Fed leaves rates near zero

At Bankrate we strive to help you make smarter financial decisions. While we adhere to strict , this post may contain references to products from our partners. Here’s an explanation for

Short-term interest rates will remain where they are — near zero percent — the Federal Reserve announced today.

The central bank’s Federal Open Market Committee, or FOMC, kept the federal funds rate within a range of zero percent to 0.25 percent. The decision was expected. The federal funds rate has been near zero percent since December 2008, and the Fed implied that it will remain at rock bottom for months more.

“Information received since the Federal Open Market Committee met in June indicates that the pace of recovery in output and employment has slowed in recent months,” the rate-setting committee said in its policy statement. It said it plans to keep short-term rates “exceptionally low” for “an extended period.”

The Fed added that it will keep pouring money into the economy by buying mortgage-backed securities as older mortgages are paid off. It will do something similar with purchases of Treasury notes.

There was one dissent. As he has done all year, Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, did not want to pledge to keep rates exceptionally low “for an extended period” because the wording ties the Fed’s hands.

Banks make overnight loans to one another at the federal funds rate, which influences the prime rate and other short-term rates. The prime rate will stay at 3.25 percent. Rates on home equity lines of credit and variable-rate credit cards will remain unchanged. Rates on short-term certificates of deposit will remain very low. Short-term interest rates are heavily influenced by the Fed. Longer-term interest rates, such as for mortgages and auto loans, are set by market forces, and not by the Fed. The central bank’s influence on long-term interest rates is indirect and unpredictable.

Fed officials have been saying for months that the economy is improving, albeit “at a moderate pace,” as chairman Ben Bernanke has phrased it in recent speeches. Lately, that pace has seemed slow rather than moderate. The economy shed 131,000 jobs in July. Unemployment remains stuck at 9.5 percent. Productivity took a dive in the second quarter, which suggests that businesses aren’t set to go on hiring sprees anytime soon.

Most of the forecasters at the Fed have revised their predictions downward. They expect the unemployment rate to be around 7 percent to 7.5 percent at the end of 2012, and for economic growth to be relatively sluggish for the next couple of years.

Even though the economy seems to be decelerating, Fed officials have been talking about what they will do when the economy accelerates. When that time comes, the central bank will keep its hands off the federal funds rate at first, Bernanke told Congress last month. Instead, he said, the Fed will pull a different lever: It will pay banks a higher interest rate on the deposits they keep in the central bank. That would pull money from circulation and help keep inflation down.

In the meantime, while the economy sputters, the Fed’s policy statement makes clear that it will keep the federal funds rate near zero — what Bernanke calls “extraordinary monetary policy accommodation.”

“Of course, even as the Federal Reserve continues prudent planning for the ultimate withdrawal of extraordinary monetary policy accommodation, we also recognize that the economic outlook remains unusually uncertain,” Bernanke told Congress.

There’s another element of uncertainty. The Fed’s actions don’t always have the expected consequences. Take mortgage rates, for example.

Over the course of more than a year, the Fed bought more than $1 trillion in mortgage-backed securities. The goal was to push mortgage rates lower. As expected, mortgage rates fell. The Fed stopped buying mortgage-backed securities at the end of April, and publicized the timetable months in advance.

Many economists predicted that the Fed’s exit from the mortgage market would cause mortgage rates to rise half a percentage point by the end of June. But mortgage rates didn’t rise. They fell to lows that hadn’t been seen in generations.