Fed stands pat on key rate

5.25% is unchanged, despite `volatile' financial markets

August 08, 2007|By William Neikirk | William Neikirk,Chicago Tribune

WASHINGTON -- The ever-cautious Federal Reserve resisted Wall Street pressures yesterday and decided to keep interest rates steady despite concerns over a possible credit crunch that could sink the economy.

About the only consolation for financial markets was the fact that the central bank at least mentioned these concerns in a statement after its meeting. That acknowledgment gave Wall Street faint hopes of an interest-rate cut later this year if credit conditions continue to deteriorate.

Tighter credit, combined with a housing correction, have slammed stock prices over the past few weeks. A high level of volatility has signaled to many that the bull market is over and that the credit crunch could be worse than believed.

The central bank, with its ability to ease or tighten financial conditions, was on the hot seat as it weighed its decision. But while mentioning the problem, it did not seem deeply concerned, judging by its short statement. It showed no stomach for bailing out Wall Street's financial overreaching.

After the announcement, stock prices declined before surging sharply, then tailing off at the end of the day. Major indexes posted modest gains.

"The downside risks to [economic] growth have increased somewhat," the Fed said in a statement after its meeting. But it added that inflation still remains its "predominant policy concern" and the prime focus of its monetary policy.

The central bank, headed by Chairman Ben S. Bernanke, almost never moves swiftly when economic conditions are relatively fuzzy or when inflation has yet to be flattened. And now the Fed appears especially worried that a rate cut could do more damage to a weak dollar overseas.

Higher energy prices also have made the central bank less inclined to ease its monetary policy and let interest rates fall. It is trying to keep a lid on inflation and head off an inflationary wage-price spiral.

The Fed kept its federal funds rate - the rate that banks charge each other for borrowing, and the benchmark for all other short-term interest rates - at 5.25 percent, where it has been for more than a year.

Peter E. Kretzmer, senior economist for Bank of America, said Bernanke's record as a student of the Great Depression was reassuring in today's climate of higher credit risks. The decision "must be seen as a judgment that such risks have not reached a critical level," Kretzmer said.

He added that he saw the central bank easing rates by the end of the year as tighter credit conditions pinch business investment and hiring decisions.

T.J. Marta, fixed-income strategist for RBC Capital Markets, said that in the next six to eight months it will become clear whether "the wheels are coming off" the economy because of credit-market troubles or whether the economy will weather the storm, as Marta's firm believes.

But if anything gave hope to financial markets, it was the fact that the central bankers at least mentioned that tighter credit markets combined with the housing downturn are hurting stock values and posing a broader risk to the financial markets.

"Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing," the central bank said.

"Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy."

As for rising prices, the statement said that readings on core inflation, which exclude food and energy prices, "have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated."

Brian S. Wesbury and Robert Stein, economists at First Trust Advisors LP in Lisle, Ill., said the Fed appeared bullish in this statement.

"This suggests the Fed is not overly concerned about consumption growth at this time and believes international trade will be supportive of [economic growth] in the near to medium term," they said.

One analyst worried about the dollar, Peter Schiff, president of Euro Pacific Capital in Darien, Conn., said an interest-rate cut would have sent the greenback plunging and diminished demand by foreigners to invest in U.S. Treasury bonds. That, in turn, would have caused long-term interest rates on bonds and mortgages to rise, he said.

"Such a scenario would expose the Fed's inability to bail out the economy," Schiff said.

William Neikirk writes for the Chicago Tribune.

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