U.S. Economy Still Shaky

By Reuters -  |  Posted 2008-08-05

WASHINGTON (Reuters) - The Federal Reserve held U.S. interest rates steady on Tuesday, expressing concerns on both economic growth and inflation and offering few clues as to when it might push borrowing costs higher.

The 10-1 decision by the U.S. central bank leaves the benchmark federal funds rate target at a low 2 percent, where it has been since April. The Fed had reduced rates by a cumulative 3.25 percentage points since mid-September in response to a sharp housing retrenchment and turmoil in credit markets.

"Although downside risks to growth remain, the upside risks to inflation are also of significant concern," the Fed said in a statement.

The announcement closely mirrored a statement issued after the Fed's last meeting in late June. However, the central bank omitted a phrase contained in the June statement that had said risks to growth appeared "to have diminished somewhat."

U.S. stocks added to earlier gains, while prices for U.S. government debt securities and the dollar slipped. U.S. short-term interest rate futures pared the implied prospects of rate hikes later this year.

Dallas Federal Reserve Bank President Richard Fisher dissented from the decision, preferring higher rates. It was Fisher's fifth straight dissent.

"If there is a subtle shift in the risk assessment it is that while acknowledging the downside risks to growth, it notes the upside risks to inflation 'are also (of) significant concern,'" Marc Chandler, global head of strategy at Brown Brothers Harriman in New York, said in a note to clients.

"This may have been a sufficient bone to the hawks to prevent others from joining Fisher in dissenting," he said.


The Fed's decision comes as evidence points to lingering economic weakness from the housing slump, shaky consumer sentiment and tight credit.

At the same time, a marked pullback in oil prices, which have slid to around $120 a barrel since cresting above $147 a barrel in July, has eased some of the central bank's worries about inflation.

The drop in oil prices had led investors to anticipate the Fed would not need to raise rates soon to combat inflation at the expense of choking off already weak growth, and was a factor pushing equities prices up ahead of the central bank's decision.

The economy grew at respectable if somewhat subdued 1.9 percent annual rate in the April-June quarter, but that growth followed a 0.2 percent contraction in the fourth quarter of last year and a tepid 0.9 percent gain at the start of 2008.

Many economists expect the economy to weaken anew in the second half of the year as the boost to consumer spending from government stimulus checks recedes.

With the jobless rate at a four-year high and employers cutting jobs for a seventh straight month in July, many observers suggest it is a technicality to insist the economy is not in recession simply because a popular definition -- two consecutive quarters of contraction -- has not been met.

At the heart of U.S. economic malaise is a housing market that has not shown convincing signs of stabilizing. The pace of existing home sales fell to the lowest level since 1998 in June and mortgage applications are at their lowest level since 2000 as buyers remain on the sidelines.

A mild silver lining is the recent drop in oil prices.

Fed officials have worried that big increases in energy and food prices could set in train an inflationary psychology in which workers and businesses push harder to cover their costs, leading to a broader pickup in prices.

A report on Monday showed inflation jumped 0.8 percent in June, the steepest rise since 1981. The gain over the past year climbed to 4.1 percent, the most since 1991.

While so-called core inflation, which excludes volatile food and energy prices and is viewed by the Fed as a good barometer of the future course of prices, has been better behaved, it also moved up in June.

Core prices have risen 2.3 percent over the past year, a bit above the 1.5 percent to 2 percent range that many Fed officials believe is ideal.

(Additional reporting by David Lawder; Editing by Tim Ahmann)