Fed keeps rates steady, says economy is "balanced"

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The Federal Reserve kept short-term interest rates steady and implied that the economy isn’t faring too badly.

The rate-setting Open Market Committee held its target for the federal funds rate at 1.25 percent. The decision means that the prime rate will remain at 4.25 percent. Consumer debt tied to the prime rate — certain home equity loans, home equity lines of credit, auto loans and credit cards — will stay about the same.

Investors had expected the Fed to hold short-term rates steady, so the decision was no surprise. They had focused attention on the balance-of-risks statement, in which the committee announces whether it believes the economy is more at risk of inflation or of poor economic growth, or if those risks are balanced.

The Fed said the risks are balanced. Observers take that as a hint that the Fed is inclined to keep rates steady again when it next meets, March 18.

“Oil price premiums and other aspects of geopolitical risks have reportedly fostered continued restraint on spending and hiring by businesses,” the rate-setting body said. “However, the Committee believes that as those risks lift, as most analysts expect, the accommodative stance of monetary policy, coupled with ongoing growth in productivity, will provide support to an improving economic climate over time.”

The statement makes clear that the Fed believes the economic climate might be stormy in the coming weeks as the confrontation with Iraq is resolved, but that things will settle down rather quickly, says Michael Cosgrove, principal of The Econoclast, an economic forecasting firm. “In the short term, the balance of risks is tilted toward weakness, but the general economy is picking up speed in the first quarter,” Cosgrove said.

The Fed has been saying since November — when it last cut short-term rates — that the risks are balanced between inflation and slow growth. Most observers predicted correctly that the Fed would not change that assessment this time. But some had speculated that the Fed would say the economy is at greater risk of economic weakness. Such a change in the balance-of-risks statement would have been interpreted as a hint that the Fed might cut rates again in March or May.

By holding the line on the balance-of-risks, the Fed is hinting that it plans to keep rates steady for a while, barring drastic changes in the economic picture. The Fed has reduced the federal funds rate 12 times since January 2001. The policy is designed to stimulate the economy, and it does: Low rates on savings accounts, certificates of deposit and money-market accounts encourage consumers to spend, not save. Low mortgage rates have put cash in the pockets of homeowners who refinanced their home loans, and have helped drive up home prices.

But the economy still needs stimulus. Economists believe the Fed is waiting for Congress to adopt tax cuts and possible spending increases to stimulate the economy.

The Fed’s decision to hold rates steady won’t have much direct effect on rates for 15-year mortgages and 30-year mortgages. Those rates already have been in somewhat of a holding pattern in the last two months as investors await a resolution to the standoff with Iraq.

The federal funds rate is what Fed-member banks charge one another for overnight loans. It also is known as the overnight rate. The Federal Reserve sets a target for the overnight rate and controls it indirectly by adding and subtracting cash from the banking system.

— Posted: Jan. 29, 2003