Fed lets low rates and QE2 ride

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The Federal Reserve Open Market Committee today maintained near-zero interest rates and its quantitative easing program, known as “QE2,” as it continued its strategy to push money into the economy.

Overall the economic recovery is on a “firmer footing,” though the housing sector remains depressed, the rate-setting panel said after its regular meeting. The Fed noted that recent surges in the price of oil and other commodities have put upward pressure on inflation but it “expects these effects to be transitory.”

The FOMC currently has 11 voting members — the six members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining 11 Reserve Bank presidents, who serve one-year terms on a rotating basis.

No change to consumer financial products

The federal funds target has remained in a range of zero percent to 0.25 percent since December 2008. When the Fed changes the federal funds target rate, it affects other short-term rates such as the prime rate. No change in the target range means that the prime rate, which stays 3 percentage points higher than the federal funds rate, will remain at 3.25 percent.

The rate-setting panel has a dual mandate from Congress to promote maximum employment and price stability. Since the last FOMC meeting in January, job growth and consumer spending have improved somewhat, but oil prices have spiked as well.

In testimony before the Senate Banking Committee on March 1, FOMC Chairman Ben Bernanke said that the Fed would “respond as necessary” if sustained increases in the price of oil or other commodities trigger inflation.

“The Fed’s concern about higher oil prices and its potential effect on the economy has further delayed the timetable for eventual interest-rate increases,” says Greg McBride, CFA and senior financial analyst at Bankrate.com.

That means that low yields on certificates of deposit will persist and variable-rate credit card holders won’t see their interest rates shift as a result of a change in the prime rate. Rates on mortgages and auto loans move with market forces.

Quantitative easing: a look back

Since the Federal Reserve hasn’t been able to further slash the target federal funds rate, it has instead eased monetary conditions over the past two years by engaging in large-scale asset purchases, or quantitative easing.

The first round, or QE1, lasted from December 2008 through March 2010 and “appears to have contributed to an improvement in financial conditions and a strengthening of the recovery,” Bernanke said in March.

QE2 began in November 2010 with the announcement that the open market committee intended to purchase $600 billion in longer-term securities through June 2011.

With the scheduled expiration of QE2 fast approaching, McBride says the Fed is due to address it. The matter must be delicately handled, he adds.

“Right now, the punch bowl is low interest rates and quantitative easing from the Fed. Any sign they’re taking away the punch bowl is not going to be warmly received by financial markets,” he says.

More quantitative easing ahead?

The FOMC did not address an exit strategy for QE2 in its statement, saying that the committee “will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.”

Any additional quantitative easing could trigger some dissension on the panel.

Richard W. Fisher, Dallas Fed CEO and new voting member of the FOMC, said in a recent public speech that he would vote against an expansion of quantitative easing, “barring some unexpected shock to the economy or financial system.”

Echoing that sentiment, Philadelphia Fed CEO Charles Plosser said in February that he would not rule out ending QE2 early if economic prospects continued to improve. “If the growth rates of employment and output begin to accelerate or if inflation or inflation expectations begin to rise, then it may be time to begin taking our foot off the accelerator,” he said.