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Federal Reserve leaves interest rates unchanged

The Fed says economic activity has picked up but is still weak.

September 24, 2009|Don Lee

WASHINGTON — The Federal Reserve said Wednesday that it would keep short-term interest rates near zero for the foreseeable future, even though the central bank acknowledged that the economy was recovering from its long downturn.

The announcement after a two-day Fed meeting makes clear that the agency is in no hurry to raise interest rates despite concerns that the federal government's soaring deficits and the Fed's extraordinary stimulus measures will eventually drive up inflation.

The Fed's policy-setting committee said evidence suggested "economic activity has picked up," compared with its Aug. 13 assessment that the economy was merely "leveling out."

This time the Fed also said that "activity in the housing sector has increased" and that businesses' pace of cutting back on investments and staffing had slowed.

But the panel, citing continuing job losses and constrained household spending, said in a statement that "economic activity is likely to remain weak for a time." Substantial slack, or unused capacity, will probably dampen cost pressures and keep inflation subdued for some time, the committee said.

The panel voted 10 to 0 to leave the target for the Fed's key short-term interest rate between zero and 0.25% for "an extended period," which many analysts interpret to mean until at least mid-2010.

Although that's good for consumers paying mortgages and credit cards, "if you're a saver, it's keeping rates down -- you hate it," said Babette Heimbuch, chief executive at the Los Angeles-based thrift FirstFed Financial Corp.

Jack Ablin, chief investment officer at Harris Private Bank in Chicago, said he was encouraged "by the unanimity of the Fed governors, that we have all of them behind this decision to keep rates low."

With high unemployment and bank lending still weak, Ablin added, "I think the Fed is taking a very realistic view. There certainly is a lot of stimulus in the system, but also a lot of slack."

The Fed also announced another cautious move toward eventually pulling back from its unusual interventions in financial markets to keep the economy from collapsing. The Fed is about two-thirds of the way through its previously announced plan to buy as much as $1.25 trillion of government agency mortgage-backed securities by the end of this year.

On Wednesday, the central bank said it would buy the full $1.25-trillion amount but would "gradually slow these purchases" until they are completed next March, along with another program to buy $200 billion in agency debt.

"The mortgage market has gotten a reprieve, and mortgage rates may stay low going into the spring of next year," said Chris Rupkey, an economist at Bank of Tokyo-Mitsubishi in New York.

But, he added, "there might be some fear that rising interest rates next spring when the Fed stops buying mortgages could put the kibosh on the recovery."

The purchases of mortgage bonds issued by government agencies have helped push down the cost of home loans. They also have made the Fed, in effect, the principal source of financing for the housing market and have contributed to a ballooning of the central bank's balance sheet. Some analysts fear that the Fed's programs are supplying the economy with too much cheap money that will lead to spiraling inflation.

The Fed's plan to wind down the purchases of mortgage-backed securities indicates a stronger confidence in the housing market as the central bank seeks to shift the financing back to the private sector.

Yet it also buys the agency time, said G.U. Krueger, an economist at HousingEcon.com, a research and consulting firm in Los Angeles.

"They're hedging their bets a little bit, keeping their options open in case the market falls again," Krueger said.

With the economy showing signs of improvement, the Fed has come under increasing pressure to address the question of an "exit strategy" for its lending programs.

"The exit strategy will become the focal point of future policy deliberations," California State University economist Sung Won Sohn said in a research note. "After all, a firefighter's first rule of survival is 'Know your way out.' "

The Fed policy-setting panel's next meeting is Nov. 3-4.

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don.lee@latimes.com

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