News and Current Events

6/25/08

Fed Keeps Rate at 2%, Ending Most Aggressive Easing Since 1980s
2008-06-25 14:09 (New York)

By Craig Torres
    June 25 (Bloomberg) -- The Federal Reserve left its benchmark interest rate at 2 percent, ending the most aggressive
series of rate cuts in two decades, as higher energy costs threaten to boost inflation.
    ``The Committee expects inflation to moderate later this year and next year,'' the Federal Open Market Committee said in
a statement today in Washington. ``However, in light of the continued increases in the prices of energy and some other
commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook
remains high.''
    Fed Chairman Ben S. Bernanke and his colleagues refreshed their forecasts at their two-day meeting and may have concluded the economy is likely to avoid a contraction. At the same time, crude oil prices have almost doubled in the past year and the cost of commodities from wheat to tin jumped to unprecedented levels.
    ``Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased,'' the Fed added. ``The Committee will continue to monitor economic and financial
developments, and will act as needed to promote sustainable economic growth and price stability.''
    As policy makers convened, reports showed U.S. home prices fell the most on record, consumer confidence touched a 16-year low, and durable goods orders were unchanged in May. Households are also falling further behind on their debt, eroding profits at lenders. Banks and securities firms have taken almost $400 billion in asset writedowns and credit losses.
    ``Tight credit conditions, the ongoing housing contraction, and the rise in energy prices are likely to weigh on economic
growth over the next few quarters,'' the Fed said. Dallas Fed President Richard Fisher dissented from today's
decision, preferring an increase. He dissented against the rate cut at the April meeting.

                       Inflation Outlook

    Oil prices touched a record $139.89 June 16, extending a rally that helped push the consumer price index up 4.2 percent
in May compared with an average rate of 2.7 percent over the past decade. Energy costs are hurting profits and household
incomes, and raising expectations for future inflation. Dow Chemical Co. said yesterday that higher raw materials
costs will cause the company to raise prices by as much as 25 percent in July, following an increase of as much as 20 percent.  United Parcel Service Inc. lowered its second-quarter profit forecast on June 23 because of rising fuel costs and slowing U.S. growth.
    American consumers foresee average annual inflation of 3.4 percent over the next five years, the highest expectation since
1995, according to the Reuters/University of Michigan survey.  ``The risks of a sharp drop in activity have probably faded
in their view,'' Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey, said before the meeting. Without slack in the economy, ``they would not be able to ride out the inflation wave.''
    Home prices in 20 U.S. cities fell in April by the most on record, signaling the housing recession is far from over. The
S&P/Case-Shiller home-price index dropped 15.3 percent from a year earlier. The gauge has fallen every month since January
2007. Employers have reduced payrolls for five consecutive months, helping push the unemployment rate to 5.5 percent.

                       Emergency Response

    Central bankers reduced the target rate for overnight loans between banks by 2.25 percentage points in 2008 with a series of aggressive rate actions, including two three-quarter-point cuts. In addition, the Fed invoked emergency authority in March to start lending directly to investment banks. The central bank also provided $29 billion of financing to secure JPMorgan Chase & Co.'s takeover of Bear Stearns Cos.
    The financial system remains under stress. The Standard and Poor's Financials Index, which includes 90 bank, brokerage and insurance stocks, fell 21 percent from May 2 to June 24.
    ``Business conditions continue to weaken in the U.S. and so far this month we have seen credit indicators deteriorate beyond our expectations,'' American Express Co. Chief Executive Officer Kenneth Chenault said in a statement today.

                   Mortgages More Expensive

    Financing rates are also rising for consumers. The rate on a 30-year fixed-rate mortgage rose to 6.3 percent June 24 versus 5.79 percent at the start of the year, according to Bankrate.com.
    ``There has been some tightening of financial conditions over the past month,'' Brian Sack, senior economist at
Macroeconomic Advisers LLC in Washington, said before the rate decision. ``That will certainly weigh on the outlook.''
    Fed officials discussed their new forecasts for 2008, 2009 and 2010 at the meeting. Bernanke will reveal the FOMC's new
outlook for inflation, growth and employment in his semi-annual congressional testimony next month.
    Wall Street analysts are divided on how higher energy costs may affect growth. The 38 percent rise in oil prices this year
absorbs more consumer dollars, pulling spending away from other goods and services. If inflation is allowed to rise further, the
purchasing power of incomes could fall. After tax incomes adjusted for inflation rose at a 1.8 percent rate for the 12
months ending April, versus 3.1 percent for the same period a year earlier.
    ``The Fed risks worsening a downturn if they turn suddenly to try and restrain a one-off increase in oil prices by hiking
interest rates,'' Chris Rupkey, chief financial economist Bank of Tokyo-Mitsubishi UFJ Ltd. in New York, said before the
meeting.
    The federal government has also injected $70.8 billion into the economy through tax rebates, which could lead to one or two quarters of stronger growth and add momentum to price increases.
    ``Headline inflation seems poised to remain high,'' Mickey Levy, chief economist at Bank of America Corp. in New York, said before the meeting. ``The Fed's accommodation threatens to turn the oil price shock into a more pervasive inflation problem.''

--With reporting by Elizabeth Stanton and Sarah Thompson in New
York. Editor: Daniel Moss, Chris Anstey