Fed May Enter Period of Unchanged Rates

Posted 26 October 2006 @ 11:55 am EET     Print     Reprint     E-Mail     Comments

WASHINGTON (AP) - The Federal Reserve, after an unbroken two-year stretch of raising interest rates, may now be entering a prolonged period where the central bank keeps rates unchanged.

It could be next June or later before the Fed makes any change in interest rates because of the opposing forces buffeting the economy at present.

Analysts hold that view because they think inflation is likely to linger at levels that will keep the Fed from cutting rates and economic growth will be too slow to think about raising rates.

The central bank, in announcing Wednesday that it was keeping the federal funds rate unchanged for a third straight meeting at 5.25 percent, cited the twin dangers it is confronting.

The Fed statement said core inflation, which excludes energy and food, remained at "elevated" levels even as overall economic growth has been slowing, reflecting in part the slowdown in housing.

Wall Street had widely expected the Fed to stand pat on interest rates, a decision that affects millions of borrowers whose credit card, home equity lines and other loans are tied to the prime rate set by banks and other private lenders in response to Fed policy. The prime will remain at 8.25 percent, where it has been since June, the last time the Fed raised rates.

Analysts saw the Fed's brief statement Wednesday as confirmation of their belief that the central bank is through raising rates but at the same time is in no hurry to start cutting rates.

"The Fed is telling us that there will be no change in monetary policy for the foreseeable future," said Mark Zandi, chief economist at Moody's Economy.com.

Lyle Gramley, a former Fed governor who is now an economic consultant in Washington, said the idea of cutting interest rates "isn't on the radar screen at all" because core inflation is running nearly a full percentage point above the Fed's upper level comfort zone of 2 percent.

But on the other hand, "The Fed knows if you were to raise rates now you could turn what is a reasonably orderly decline in housing into a rout and threaten pushing the economy over into a recession," Gramley said.

Federal Reserve Chairman Ben Bernanke earlier this month said the "substantial correction" going on in housing would shave growth by a full percentage point in the second half of this year.

After beginning the year with a 5.6 percent rate of growth, the economy slowed to a sluggish 2.6 percent rate in the spring. Analysts believe growth in the just-concluded third quarter slowed even further to 2 percent or less. The government will report the actual number on Friday.

Nariman Behravesh, chief economist at Global Insight, said he believed the economy, after slowing to a lackluster growth rate of 1.5 percent in the third quarter, will rebound to growth of around 2.5 percent in the final three months of this year as consumers are helped by the recent big declines in the cost of gasoline and other energy products.

That would still be below the economy's long-run trend of around 3 percent, which means unemployment is likely to tick up from the current low for this recovery of 4.6 percent to possibly 4.8 percent by the middle of next year.

But by that time, the sub-par growth will have helped to lower core inflation enough that the Fed will feel comfortable in beginning to cut rates, analysts said, setting the stage for stronger growth in 2008.

Economists believe that while the Fed keeps short-term rates unchanged, long-term rates will probably move higher as financial markets realize their expectations for quicker Fed rate cuts will not be realized.

Rates on 30-year mortgages, which dipped as low as 6.3 percent in early October when hopes for Fed rates cuts starting this year were at their highest, are expected to rise slightly to around to around 7 percent by this time next year.

Of course, if a sudden spike in energy prices rekindles inflation, the Fed might feel the need to boost rates further. Or if the weakness in housing threatens an economy-wide recession, the Fed might ride to the rescue with faster rate cuts.

"There is a lot that can change between now and next year," said David Wyss, chief economist at Standard & Poor's in New York. "Oil prices could go back up just as quickly as they came down."