Fed leaves funds rate unchanged at 2 percent

August 5, 2008 12:24:13 PM PDT
The Federal Reserve, confronted with the perils of a slumping economy and rising inflation, has decided for a second straight meeting to leave interest rates unchanged.The Fed announced Tuesday that it was keeping its target for the federal funds rate, the interest that banks charge each other, at 2 percent.

Wall Street seem pleased with the decision. Share prices had been higher most of the day after oil dropped to around $118 a barrel. They gained a little more speed when the announcement came in as expected and the central bank didn't tip its hand on when it might begin raising rates again.

In midafternoon trading, the Dow rose 284.72, or 2.52 percent, to 11,568.87. It was up about 225 points shortly before the Fed's 2:15 p.m. EDT announcement.

Private economists said they viewed the Fed's brief announcement as a strong signal that the central bank could remain on hold until after the November presidential election, even though there was again a dissent from one Fed official who argued that rate hikes were needed now to fight inflation.

"I think the Fed would rather wait until after the election before they consider raising rates," said David Jones, chief economist at DMJ Advisors. Jones predicted the central bank will likely leave rates alone at its next two meetings in September and October and make the first rate hike at the final meeting of the year in December.

"That will give them time to get a better view of the economy and see if financial markets have become less fragile," Jones said.

The Fed is caught between what many economists believe is a recession and rising inflation pressures, triggered by this year's huge runup in energy prices.

The Fed decision means that commercial banks' prime lending rate, the benchmark for millions of consumer and business loans, will remain unchanged at 5 percent, its lowest level since late 2004.

The statement said that "tight credit conditions, the ongoing housing contraction and elevated energy prices are likely to weigh on economic growth over the next few quarters."

The central bank also said it believes that "over time" the significant rate cuts it has already put in place plus the sizable operations to supply additional money to financial institutions should help to promote a return to "moderate economic growth."

On inflation, the Fed said it expected a moderation in price pressures later this year and next year but cautioned that "the inflation outlook remains highly uncertain."

The Fed also left rates unchanged at its last meeting on June 24-25, a decision that marked the end of the Fed's most aggressive period of rate cuts in more than two decades. Those reductions were engineered to protect the economy from turmoil in financial markets caused by billions of dollars of losses on home mortgages.

Many economists believe the Fed will leave the funds rate at 2 percent for the rest of this year. The hope is that recent declines in oil prices will be sustained and take pressure off inflation without forcing the central bank to begin raising rates while unemployment has been rising sharply.

The Fed got good news on the inflation front Tuesday. Oil prices dropped as low as $118 per barrel, the cheapest they've been since early May. Crude has now fallen more than $25 since reaching a trading high of $147.27 on July 11.

Last week, the Labor Department reported that the nation's unemployment rate jumped to 5.7 percent in July as businesses laid off workers for the seventh straight month, a string that normally signals the start of a recession.

Those layoffs and the fragile state of the financial sector would normally keep the Fed from raising interest rates. Some Fed officials have been arguing, however, that the central bank runs the risk of losing its inflation-fighting credibility if it delays fighting growing inflation problems. The government reported that a big surge in gasoline and food costs pushed consumer prices up by 1.1 percent in June, leaving them rising by 5 percent over the past year, the largest increase since 1991.


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