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First halt in fed rate increase after 2 years { July 2006 } Original Source Link: (May no longer be active)
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Fed Skips Interest-Rate Increase, Ending Two-Year Run (Update2)
Aug. 8 (Bloomberg) -- The Federal Reserve kept the benchmark U.S. interest rate at 5.25 percent, ending a record two-year run of increases while leaving room for further moves should higher inflation persist.
``Some inflation risks remain,'' the Federal Open Market Committee said in a statement after meeting today in Washington. ``The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.''
In their toughest decision since Chairman Ben S. Bernanke took the Fed's helm in February, central bankers are counting on economic growth slowing enough to damp a pickup in prices. If they make the wrong call, policy makers may have to clamp down harder in coming months and risk smothering the expansion. St. Louis Fed President William Poole said last week he was ``50- 50'' about whether to keep lifting borrowing costs.
``They have time to look at the data,'' Robert Parry, former president of the San Francisco Fed, said after the decision. ``If it looks like they should tighten further, they will.''
Lacker's Opposition
The FOMC's decision left the target for the overnight lending rate between banks at the highest level since March 2001. Richmond Fed President Jeffrey Lacker cast the first opposing vote of Bernanke's term, arguing instead for a quarter- point increase.
``Economic growth has moderated from its quite strong pace earlier this year,'' the statement said. ``The high levels of resource utilization and of the prices of energy and other commodities have the potential to sustain inflation pressures. However, inflation pressures seem likely to moderate over time, reflecting contained inflation expectations and the cumulative effects of monetary policy actions.''
Treasury notes gained after the statement, which played down recent inflation indicators in favor of a prediction price pressures will abate. Stocks jumped in the minutes after the decision before retreating.
The majority of economists expected today's decision after a report on Aug. 4 showed U.S. employers added fewer jobs than forecast in July and the unemployment rate rose. Bernanke laid the groundwork for a pause on July 19, when he told Congress the Fed must be mindful of effects of past decisions still ``in the pipeline.''
Today's move ends the Fed's longest streak of increases without a pause or cut since the FOMC began announcing the direction of moves in the target rate in 1994. The rate was 1 percent when policy makers began a series of 17 consecutive quarter-point moves in June 2004.
Grasping Opportunity
Fed policy makers are taking advantage of the first clear opportunity to pause since Bernanke in April explicitly said central bankers may soon do so. New data show slower economic and job growth, while a drop in Treasury yields over the past month indicates investors are acknowledging the situation and expecting the Fed to take a break from rate increases.
Yet by pausing now, Fed officials may be risking even higher inflation if their forecast is wrong. The Fed's preferred price gauge, which excludes food and energy costs, increased 2.4 percent in June from a year earlier, the fastest clip since September 2002. Bernanke and other officials have said they're comfortable with inflation between 1 percent and 2 percent.
Productivity
Also, in the second quarter, U.S. productivity gains eased and labor costs rose the most since the end of 2004, the Labor Department said in a report today, suggesting rising wages may exacerbate a pickup in inflation.
Because of the surge in energy costs, the Fed isn't as far ahead of inflation as at the past two interest-rate peaks under Bernanke's predecessor, Alan Greenspan. At 5.25 percent, the fed funds rate is about 1 percentage point above the full measure of the consumer price index, compared with about 3 points in late 2000 and early 1995.
``The main error in the marketplace right now is the tendency for people to view a pause in policy as an end to the tightening cycle,'' Ethan Harris, chief U.S. economist at Lehman Brothers Holdings Inc. in New York, said before the decision.
``The inflation numbers are going to force the Fed to keep hiking,'' said Harris, a former head of domestic research at the New York Fed. He still expected the FOMC to raise rates at two of the three remaining meetings this year.
Harris on July 31 changed his prediction for today's meeting to a pause from a quarter-point rate increase, citing the government's July 28 report that the U.S. economy expanded at a 2.5 percent annual pace in the second quarter, less than half the rate of the first three months of 2006.
Out of Sync
Other central banks in the world's largest economies are picking up the pace as the Fed slows down.
The European Central Bank has raised its main rate four times since December to 3 percent after holding it at 2 percent for two years. The Bank of England pushed up its rate Aug. 3 for the first time in two years. The Bank of Japan raised borrowing costs for the first time in almost six years on July 14.
Looking Back
For their part, U.S. policy makers were raising rates from unusually low levels and started doing so well before other countries began to follow. One of the reasons Fed policy makers are pausing now is because they believe the economy hasn't yet seen the full effect of previous increases. Such moves may take three to 18 months to bear fruit, Donald Kohn, vice chairman of the Fed's Board of Governors, said in June.
Key to the slowing economy has been a cooling housing market. Since the Fed began raising rates, the average rate on a one-year adjustable mortgage has jumped to 5.69 percent from 4.13 percent, according to Freddie Mac. The number of unsold homes on the market has almost doubled since January 2005.
Bernanke told Congress last month that the housing slowdown ``so far appears to be orderly.'' Still, San Francisco Fed President Janet Yellen said last week that ``we can't ignore the risks of more unpleasant scenarios developing.''
To contact the reporter on this story:
Scott Lanman in Washington at slanman@bloomberg.net.
Last Updated: August 8, 2006 14:41 EDT
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