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Fed Leaves Rate Steady; No Sign of Future Cut

NY Times | August 7, 2007
JEREMY W. PETERS

The Federal Reserve today largely sidestepped the growing anxiety over how tightening credit standards will affect the economy, deciding to leave its benchmark interest rate unchanged at 5.25 percent.

More important than the decision to hold rates steady — which was widely expected — the Fed did not significantly adjust the language in its statement explaining the decision. Many on Wall Street expected the recent tumult in credit markets to prompt the Federal Open Market Committee to shift its focus from vigilance against inflation to the possibility of an economic downturn. Such a move would open the door for the Fed to lower interest rates in the future — something many investors have been hoping for since the Fed stopped raising rates last summer.

Although it acknowledged the recent problems, its central message was unchanged.

“Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing,” the Fed's statement said. “Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.”

The Fed decision today sent Wall Street lower immediately after the statement was released at 2:15. But stocks later recovered. At the close, the Standard & Poor's 500 stock index was up 0.6 percent, to 1,476.71, and the Dow Jones industrial average was up 0.3 percent, to 13,504.30. The Nasdaq composite index gained 0.6 percent, to 2,561.60.

Energy stocks led the market's resurgence, and even financial stocks, which fell after the Fed statement was released, recovered and helped lead the market up.

“I think the markets were hoping for something a little more evidencing or potentially pointing toward more flexibility on the part of the Fed,” said Jack Caffrey, an equity strategist with JPMorgan Private Bank. Instead, he added, the Fed essentially said “there is uncertainty in the markets, but that uncertainty remains a financial issue rather than a real economic issue.”

The stock market has been on edge for the last two weeks as concern spread that tighter lending standards for everyone from large corporations to would-be home buyers would stamp out economic growth.

But the Fed sees the current situation less urgently than many on Wall Street do. In testimony on Capitol Hill last month, Ben S. Bernanke, the Fed chairman, repeated the central bank's position that it is more concerned about rising inflation than a slowing economy. And while the Fed has acknowledged that the slowdown in the housing market and stiffer lending standards will dent economic growth, it sees the economy picking up speed in the second half of this year.

Its economic forecast for the year has become only slightly more pessimistic since February, despite the growing problems with housing.

Analysts said this is because the Fed under Mr. Bernanke seems comfortable taking the long view. That is a sharp contrast to his predecessor, Alan Greenspan, who was much more willing to offer reassuring words to Wall Street in times of market uncertainty.

“Ben Bernanke is more standoffish,” said Drew Matus, an economist with Lehman Brothers. “He's the guy sitting there watching the kids in the playground. And if there's a fight, he's going to stay out of it unless somebody's going to get hurt. Greenspan was more like a doting parent.”

To be sure, the Fed statement did make a passing reference to the possibility that the economy could deteriorate further. It added the phrase “Although the downside risks to growth have increased somewhat,” to the sentence explaining that inflation remained the biggest worry for central bankers.

The Fed's tone since it first halted a two-year string of interest rate increases a year ago this week has been more or less constant: Inflation has not settled down enough to put a rate cut on the table. It has changed its words just slightly to acknowledge shifting forces like moderating inflation and the continuing slump in housing.

But speeches by Fed officials and statements from the open market committee have made it clear that while inflation appears to be inching downward, it is going to take a while longer for central bankers to be satisfied.

“A sustained moderation in inflation pressures has yet to be convincingly demonstrated,” the statement said today, echoing verbatim the wording the Fed has used since March.

The recent tightening in the credit markets pose the most significant challenge to policymakers since June 2006, when the Fed last raised rates. In the last year, the central bank has been able to hold rates steady because both economic growth and inflation rate have been slowing at a modest, manageable pace.

Now, however, policymakers appear to be facing a more jarring — and complicated — reality. The economy and the job market remain relatively healthy, but the credit market tightening has significantly raised the borrowing costs for consumers and businesses.

And in the second quarter, the measure of inflation preferred by the Fed edged down into the range that policymakers have said they are comfortable with.

Still, economists note that Fed officials are loath to appear as if they are rescuing investors by cutting rates at the first sign of trouble.

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