Fed sticks with 5.25%

Central bank leaves rates unchanged, says `inflation risks remain'

September 21, 2006|By William Neikirk | William Neikirk,Chicago Tribune

WASHINGTON -- The Federal Reserve decided yesterday to keep interest rates steady even as it stared an abundance of future economic uncertainty in the face.

Holding its benchmark short-term interest rate at 5.25 percent for the second straight meeting, the nation's central bank issued a skimpy analysis of the economy that left few clues as to its next move, suggesting its members are uncertain about the outlook.

The vote was 10-1 in favor of standing pat, with Jeffrey Lacker, head of the Richmond Federal Reserve Bank, dissenting. Lacker wanted to increase interest rates by one-quarter of a percentage point.

"They're in a fog, with no clear vision of where the economy is headed in the next three to six months," said John Silvia, an economist at Wachovia Bank.

Paul Kasriel, an economist at Northern Trust Co., said, "The main uncertainty is how much further and longer the economy is going to be slowing," especially with a housing market that has fallen faster than expected.

Kasriel added that economic indicators are "flashing a recession warning," with a 40 percent to 45 percent chance of an actual downturn.

Analysts said the central bank likely won't raise interest rates again in the current economic cycle, and that the next move could well be down. This is good news for consumers with adjustable-rate loans.

At the same time, economists view the current interest rate regime as being restrictive, or tight enough to slow inflation as well as the economy. The full impact of its monetary policy might not be fully felt until the middle of next year, said John Miller, head of municipal portfolio management for Nuveen Investments.

The plethora of uncertainties is enough to give the Fed pause.

One economic consultant, Bernard Baumohl, executive director of Economic Outlook Group LLC, said the central bank is looking at four possible developments.

He said these are continuation of slow growth and little movement on interest rates until next year, a recession caused by a housing bust, a surge in inflation that would lead to higher interest rates and a "soft landing" featuring solid growth and low inflation.

17 straight rises

Baumohl said the soft-landing outlook, which he said could trigger a new round of non-inflationary growth, "holds the lead as the most likely to unfold."

Fed Chairman Ben S. Bernanke is responsible for bringing the central bank's 17 straight increases in interest rates to a halt. The Fed took a pause from rate increases at its last meeting, feeling it needed to assess the economic picture thoroughly before moving again.

Twofold threat

Although the housing market is cooling, the Fed said inflation risks remain even though energy prices have abated. It gave no indication as to which threat seemed more imminent, recession or more inflation.

The central bank said "moderation in economic growth appears to be continuing, partly reflecting a cooling of the housing market."

Its policymaking arm, the Federal Open Market Committee, said inflation pressures "seem likely to moderate over time," as a result of the continued decline in energy prices and a tight monetary policy.

"Nevertheless, the committee judges that some inflation risks remain," the statement said, and pledged to act if consumer price levels should head higher in coming months.

Stuart Schweitzer, global markets strategist for J.P. Morgan Asset and Wealth Management, said he interpreted the statement as saying that "inflation has started to go the right way, but that it is too soon to declare victory. They will tighten again if a problem should resurface."

Schweitzer said it is "very difficult to determine how the housing slowdown will really unfold. I think what the Fed can do for housing is to bring inflation down, because if inflation is down, interest rates can come down."

A dimmer view

Northern Trust's Kasriel took a dimmer view, saying the Fed appears to be "somewhat alarmed with the magnitude and speed of the housing slowdown, and uncertain about its multiplier effects on the rest of the economy. It doesn't know as yet [what will happen]."

Kasriel said the central bank "has no real choice but to stay on hold and pretty much keep its options open" until the uncertainties are clarified. He added that he expects an interest-rate cut in December. The Fed next meets in October.

William Neikirk writes for the Chicago Tribune.

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