Fed leaves short-term rates alone, says economy is stumbling

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The Federal Reserve has kept short-term interest rates unchanged and says the economy isn’t doing as well as had been expected.

At least for the next few weeks, loans tied to the prime rate — some credit cards, car loans, home equity loans and home equity lines of credit — won’t change much, if at all. Long-term mortgage rates will do their own thing because they aren’t affected directly by the Federal Open Market Committee’s rate-setting moves.

The committee issued a statement saying that “the risks are weighted mainly toward conditions that may generate economic weakness.” Economists and investors interpret that as meaning that the Fed is leaning toward cutting rates later this year if business investment doesn’t pick up or if consumers snap shut their pocketbook.

“The current accommodative stance of monetary policy, coupled with still-robust underlying growth in productivity, should be sufficient to foster an improving business climate over time,” the Fed’s open market committee announced.

The Fed’s rate-setting body kept its target for the federal funds rate at 1.75 percent. Also known as the overnight lending rate, the federal funds rate is what banks pay one another for overnight loans.

The prime rate, which is what banks charge their best customers, is based on the federal funds rate. In turn, some consumer credit cards, car loans and home equity lines of credit, are based upon the prime rate. The prime rate will remain at 4.75 percent, where it has stood since December. A year ago, the prime rate was 6.75 percent.

Rates on short-term consumer debt will remain steady until the Fed moves the overnight rate up or down.

With the prime rate staying the same, it’s easy to predict that short-term consumer debt will remain steady. But it’s anyone’s guess what will happen to mortgages. Investors had been pining for a Fed rate cut. As it became clear over the last few days that a rate cut wasn’t forthcoming, investors drove the yields on 10-year Treasury notes to near-record lows. Mortgage rates tend to move in the same direction as the yields on 10-year Treasury notes, so mortgage rates have dropped this week.

No one knows whether mortgage rates will continue to drop or climb back up. Right now, a borrower with good credit can get a 30-year mortgage at less than 6.5 percent. By historical standards, you’re getting a great deal if you lock at 6.5 percent or less for a 30-year mortgage. They have a lot more room to move up than to move down.

After growing at a 5 percent rate from January through March, the economy cooled to a 1.1 percent growth rate from April through June. Things haven’t got much better since the Fed’s last rate-setting meeting, June 25 and 26. Major stock indexes have declined and investors remain wary of dishonest corporate earnings reports. In its statement, the Fed said these worries have prolonged the “softening” in the economic recovery.

Through 2001 and into 2002, the Fed had said the economic risks were weighted toward weakness. In March, the Fed changed its tune and said the risks were balanced between inflation and economic weakness. Now the Fed says the scale has tipped again toward economic weakness.

Since the Fed’s rate-setting committee last met on June 25 and 26, major stock indexes have declined. Investors hoped the Fed would step in and cut rates to boost the economy. But the recovery from last year’s recession has continued to plod along, slowly and with occasional missteps, and the Fed has elected not to tamper with it.

The economic news has been mixed. The total number of nonfarm jobs has gone up for three months, but analysts were disappointed that net job creation was up just 6,000 jobs in July, when they expected 60,000. The gross domestic product increased 1.1 percent from April through June, much lower than expected — but at least it increased.

As the open market committee began its meeting, the Commerce Department reported that retail sales in July rose 1.2 percent, as expected. That was considered good news for the economy and bad news for people who expected a Fed rate cut.

“We’re in a rough spot, but the good outweighs the bad,” President Bush said Tuesday at an economic forum in Waco, Texas. “We had three quarters of negative growth when I took office; now we have had three quarters of positive growth. The trend is in the right direction.”

Just a month or so ago, investors and economists had been expecting the Fed to start raising short-term interest rates by the end of the year. That looks extremely unlikely now. Some observers predict that the Fed will cut rates sometime this year. The futures market at the Chicago Board of Trade has priced in about a 34 percent probability of a Fed rate cut to 1.5 percent by the end of September. The committee’s next meeting is scheduled for Sept. 24.

Other observers predict that the Fed will hold rates steady through this year and raise rates early next year.

The Fed cut the federal funds rate 11 times in 2001, from 6.5 percent to 1.75 percent, a 40-year low. The last rate cut was Dec. 11, and the Fed has stood pat since then. The Federal Reserve controls the rate indirectly by adding and subtracting cash from the banking system.

— Updated: Aug. 14, 2002