Federal Reserve Holds Rates at 2% - TheStreet

Federal Reserve Holds Rates at 2%

The central bank again leaves the key interest-rate untouched, noting the outlook 'remains highly uncertain' and upside risks are of 'significant concern.'
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Updated from 2:14 p.m. EDT

The

Federal Reserve

held its key interest-rate target steady Tuesday, indicating that the central bank's decision to support economic growth with a 2% target, rather than thwart inflation with rate hikes, has gone according to plan.

The Federal Open Market Committee noted that the job, credit and housing markets remain under stress and that high energy prices threaten to put pressure on future economic growth. However, it reiterated its position that the economy will stay afloat with the initiatives already put in place.

"Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth," the FOMC said in a statement.

While economic output remained positive in the second quarter -- with GDP growing a less-than-expected 1.9% -- that growth was driven in part by consumer spending that was boosted by federal tax rebates. Now that most of those checks have been spent, boosting economic activity in the latter half of the year may prove more challenging.

The market had largely expected the Fed's move -- or lack thereof -- having already sent the

Dow Jones Industrial Average

up more than 200 points early Tuesday as oil futures dropped below $118 per barrel and a report showed better-than-expected performance in the services sector.

"This should be seen as more of a nonevent -- really a continuation of what we've seen coming from the Fed for a while," says Jason Pride, director of research for Radnor, Pa.-based Haverford Investments.

The Fed lowered its target by 325 basis points from September through April to ease the cost of lending and promote economic growth, but has held it steady since then. The rate target directly affects short-term loans between banks, but has a trickle-down effect on other consumer loans and thus affects prices and demand in the struggling housing market.

On the other hand, cheaper dollars can lead to higher costs for oil and other commodities, which are traded in dollars. Those costs translate into higher consumer prices, which rose 5% in June -- the highest level in more than 17 years -- due mostly to commodity prices. However, core inflation, which excludes food and energy costs, rose a more modest 2.4%.

The FOMC says it expects inflation to "moderate later this year and next year," but noted that the outlook "remains highly uncertain" and that upside risks are of "significant concern."

Despite those worries, rumblings of a possible rate-hike largely dissipated from the market after the FOMC's last meeting in late June. The committee held the rate steady saying it expected "inflation to moderate later this year and next year." Comments by Fed Chairman Ben Bernanke before Congress also seemed to indicate that the agency would hold off on rate movements until the economic picture was less muddied.

"Higher interest rates put downward pressure on home prices," says Lincoln Anderson, chief economist at LPL Financial. "Given the precarious place housing is in, they just don't want to mess with the housing sector right now -- they want to get a floor under home prices."

Anderson, like many economists and market observers, expects the Fed to hold its rate target steady perhaps through the end of 2008, especially if oil prices continue to decline.

Pride reiterated that view, saying a rate hike this year is "really a long shot," barring any major increases to inflation. He notes that the Fed has fine-tuned its communication to give the market a clear picture of where rates are headed and what factors will weigh most on its decisions.

"There's no reason for the FOMC to step out of that box -- there's no good reasoning behind it -- so why upset the marketplace?" he says.

Bernanke voted in favor of the decision, as did Vice Chairman Timothy Geithner and the eight other governors: Elizabeth Duke, Donald Kohn, Randall Kroszner, Frederic Mishkin, Sandra Pianalto, Charles Plosser, Gary Stern and Kevin Warsh. Only one Fed governor, Richard Fisher of Dallas, who has been consistently hawkish on inflation, voted for an increase in the federal-funds rate target.