Fed Leaves Interest Rates Unchanged, Says Economy at Risk of Recession

(Updated from 2:16 p.m. EST)

The Federal Reserve left interest rates unchanged at its meeting today and suggested it will lower rates in the near future, perhaps as soon as at its next meeting on Jan. 30-31.

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Abandoning its previous view that the risk of rising inflation was too great to allow contemplation of lower interest rates, the Fed said the risks facing the economic expansion "are weighted mainly toward conditions that may generate economic weakness in the foreseeable future." The implication is that the Fed will lower interest rates to stimulate the economy and prevent a recession.

The statement came as a surprise to many on Wall Street. In a poll taken by Reuters yesterday, 23 of 26 economists at primary dealer firms predicted the Fed would merely confirm that it is not contemplating raising rates again. Only a few forecast that it would show an inclination to lower rates.

At its final meeting of the year, the Federal Open Market Committee , the Fed's monetary policy arm, opted to leave the fed funds rate at 6.5%, where it has stood since May. Over the previous 11 months, the FOMC raised rates six times, starting from a low of 4.75%. Its purpose was to slow the pace of economic growth in order to keep inflation from accelerating.

Growth has definitely slowed. The economy is estimated to have grown at a rate of 2.4% in the third quarter, and economists expect an even slower rate in the current quarter. In the previous four quarters, the economy grew at rates close to or exceeding 5%.

In its statement announcing the decision on interest rates, the FOMC offered a new assessment of economic conditions. In its statements since early 1999, it has maintained that the main risk to economic growth was the prospect of accelerating inflation. Today's statement says the risk of a recession is now greater than the risk of accelerating inflation. Accordingly, the Fed can lower interest rates without fear that doing so will cause inflation to accelerate.

Before yesterday, most economists considered it very unlikely that the FOMC would go directly from declaring inflation the main risk to the economy to declaring recession the main risk. They expected the committee to take the intermediate step of saying that inflation and recession were equal threats, an assessment that would have cast doubt on the prospect of a rate cut early next year. But an article in the Wall Street Journal yesterday disclosed that some FOMC members were in favor of skipping that step.

Stocks fell back after the Fed's decision was announced.