TOPICS > Economy

Fed Opts to Leave Key Interest Rate Unchanged

BY Admin  August 5, 2008 at 3:50 PM EDT

Fed Chairman Ben Bernanke

The announcement that it would maintain its target for the federal funds rate, the interest that banks charge each other, had been widely expected by financial markets, the Associated Press reported. Shortly after the announcement, the Dow Jones industrials were up 227 points to 11,511.

On inflation, the Fed said it expected a moderation in price pressures later this year and next year but cautioned that “the inflation outlook remains highly uncertain.”

The Fed is caught between what many economists believe is a recession and rising inflation pressures, triggered by this year’s skyrocketing energy prices.

Its decision means that commercial banks’ prime lending rate, the benchmark for millions of consumer and business loans, will remain unchanged at 5 percent, its lowest level since late 2004.

“There are not any surprises here,” Joe Davis, chief economist for Vanguard told Reuters of the Fed’s move. “They are trying to navigating a very tough climate, In this environment the best is to do nothing. They are still expecting the economy to firm in 2009.”

Other economists saw the Fed’s decision as a sign the policy-making board may put rate changes on hold until after the presidential election.

“I think the Fed would rather wait until after the election before they consider raising rates,” David Jones, chief economist at DMJ Advisors, told the AP. Jones predicted the central bank will likely leave rates alone at its next two meetings in September and October.

A Fed statement said that “tight credit conditions, the ongoing housing contraction and elevated energy prices are likely to weigh on economic growth over the next few quarters.”

The central bank also said it believes that “over time” the significant rate cuts it has already put in place plus the sizable operations to supply additional money to financial institutions should help to promote a return to “moderate economic growth,” the AP reported.

While oil has been trading at its lowest price in recent months, fetching less than $120 barrel, inflation still remains an issue for the American economy

In June, a big surge in gasoline and food costs pushed consumer prices up by 1.1 percent, leaving them rising by 5 percent over the past year, the largest increase since 1991. However, the inflation is not occurring during a period of growth, but rather in a period of near stagnation.

Home foreclosures and unemployment are both up as banks continue to face the consequences of billions of dollars of bad mortgage loans in their portfolios. Food costs also continue to rise and drive inflation.

The key fund interest rate is down from a high of 5.25 percent in September 2007. While the credit crisis was in full swing, the Fed lowered the rate seven times until its last meeting in June to keep liquidity in the market — marking the end of its most aggressive period of rate cuts in more than two decades.

Many economists expect the Fed to keep the funds rate at 2 percent through year’s end. The hope is that recent declines in oil prices will be sustained and take pressure off inflation without forcing the central bank to begin raising rates in the face of sharply rising unemployment.

Last week, the Labor Department announced that the U.S. unemployment rate jumped to 5.7 percent in July as businesses laid off workers for the seventh straight month, a string that normally signals an economy in recession.