Fed lets rates ride

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In a decision as widely expected as a sunrise, the Federal Reserve left interest rates alone today.

The Fed’s rate-setting Federal Open Market Committee maintained the target federal funds rate at 1.25 percent. The federal funds rate, also known as the overnight rate, is what member banks charge to one another for short-term loans to cover reserves.

“The committee continues to believe that this accommodative stance of monetary policy, coupled with still robust underlying growth in productivity, is providing important ongoing support to economic activity,” the rate-setting committee said, explaining that it expects the economy to improve. “The limited number of incoming economic indicators since the November meeting, taken together, are not inconsistent with the economy working its way through its current soft spot.”

The decision to hold the overnight rate steady means 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.

It’s harder to judge how the Fed’s decision will affect rates on 15- and 30-year mortgages. Those long-term rates don’t respond directly to changes in the overnight rate. Instead, they are affected by broader economic factors.

In fact, mortgage rates increased slightly in the weeks after Nov. 6, when the Fed cut short-term rates by half a percentage point. During most of that time, the economic news was mixed but tilted slightly in favor of improvement. Last week’s disappointing jobless report — an unemployment rate of 6 percent and 40,000 jobs lost in November — has caused mortgage rates to dip.

Last time around, the Fed cut the overnight rate and said the action “should prove helpful as the economy works its way through this current soft spot.” Last week’s unemployment news confirmed that the economy is still going through that soft spot. Fed rate cuts generally take several months to show their full effects, so the current economic situation probably hasn’t caught the Fed too much by surprise.

David Littmann, chief economist for Comerica Bank in Detroit, says he expects the Fed to take no rate action until the second half of 2003: “They’re going to take a sabbatical here,” he says. “They’ll take a six-month, paid vacation.”

There’s little more that the Fed can do to stimulate the economy, Littmann says. “There’s a shift in the action — all the action has gravitated to the Treasury and the Council of Economic Advisers.”

The next time the Fed touches rates, it will raise them, Littmann predicts, reiterating that he doesn’t expect that to happen until the second half of next year.

Dean Baker, co-director of the Center for Economic Policy and Research, isn’t so sure that the Fed has cut rates for the final time. If the economic news grows grimmer over the next six weeks, the rate-setting committee might cut again at its next meeting on Jan. 28 and 29.

Baker doesn’t agree with the Fed’s balance-of-risks statement, in which the rate-setting body says the risks of inflation and economic weakness are roughly the same. “The data is showing a lot of weakness in the economy,” Baker says, citing unemployment, declining manufacturing, and poor holiday and auto sales.

The Fed reduced the overnight rate 11 times in 2001, from 6.5 percent at the beginning of the year to 1.75 percent at year’s end. When it made the first cut on Jan. 3, 2001, the economy wasn’t yet in recession; at the last cut of 2001, on Dec. 11, the economy was on its way out of a shallow recession. The economy grew vigorously this spring, but stalled in the summer. After waiting a few months for an uptick, the Fed made its Nov. 6 cut.

The Fed sets a target for the overnight rate and controls it indirectly by adding and subtracting cash from the banking system.

— Posted: Dec. 10, 2002