Fed leaves interest rates unchanged

Federal Reserve
  • Economists can't blame stalled GDP to weather, earthquake disruptions.
  • The downgrade of U.S. credit increases uncertainty in the markets, economy.
  • Yields on savings products will stagnate; loan rates may rise slightly.

Meeting today amid a veritable hailstorm of dismal economic developments, the Federal Reserve's Open Market Committee, or FOMC, opted to leave short-term interest rates at rock-bottom levels once again.

For the first time ever, the FOMC rate announcement contained a specific date at which interest rates could be raised. It's a clear departure from the usual "extended period" language the markets have come to expect.

"The Committee currently anticipates that economic conditions -- including low rates of resource utilization and a subdued outlook for inflation over the medium run -- are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013," according to the press release.

Not surprisingly the announcement also acknowledged that growth this year has been slower than expected.

The August meeting follows several economic reports indicating increasingly slow growth in the U.S., notably the release of the second quarter gross domestic product, which pegged growth from April through June at an annualized rate of 1.3 percent -- one-third the level projected by the Fed in January.

The decision took place during an unnerving week in which the stock market saw the biggest one-day loss since 2008, following the historic downgrade of the nation's credit rating by Standard & Poor's late Friday afternoon.

The FOMC statement indicated that inflation may not rise above comfortable levels and acknowledged the fragile state of the economy. Both indicators hint that more quantitative easing from the Fed could be available in the future.

The Fed will continue to reinvest principal payments from securities already purchased under the asset purchasing programs and is "prepared to adjust those holdings as appropriate."

Economy weaker than expected

As recently as the last FOMC meeting in June, economic policy was predicated on the belief that the problems plaguing the economy were transient in nature. Rising inflation and slower-than-anticipated growth were attributed to disruptions to the auto supply chain as a result of the earthquake in Japan, skyrocketing oil prices and bad weather throughout the spring.

However, "the latest numbers we've received suggest that the weakness in the economy is much more broad-based, probably not just a temporary factor as we believed for quite some time," says Adolfo Laurenti, deputy chief economist at Mesirow Financial in Chicago. "There is something more structural at play."

Former Federal Reserve governor Lyle Gramley agrees.

"The revision in GDP that we had with this last report was quite sobering. We had a significant downward revision in the first quarter GDP and the three-year revisions indicated that the recession was deeper than we thought it was. We had a very weak second quarter, and I think that indicates that the economy doesn't have the kind of strength we thought we saw developing late last year," he says.

Despite the dismaying labor market conditions, slower household spending and depressed housing sector, the FOMC did find a silver lining in the economy.

"Business investment in equipment and software continues to expand," they reported in the press release.

What's in store for consumers

Yield-starved savers will find no relief from the Fed's ongoing interest rate policy. Rates on deposit products and fixed-income investments will remain extremely low. Borrowers may still benefit from the record-low rates.


However, loan rates may increase slightly as a result of the U.S. credit downgrade from triple-A to double-A-plus by Standard & Poor's last week.

Though short-term interest rates as set by the Fed remain unchanged, "you could see credit card issuers boost rates, particularly for riskier borrowers. Car loan rates may move up a little bit and mortgages may give back a little of the big decline seen over the last few weeks. But that is small potatoes compared to the impact a recession would have," says Greg McBride, CFA, Bankrate's senior financial analyst.

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