Fed says recession easing, inflation tame
AP Economics Writer
WASHINGTON – The Federal Reserve sought Wednesday to defuse fears that the trillions it’s spending to revive the economy could spark inflation later on. But Wall Street didn’t seem to buy it.
Fed Chairman Ben Bernanke and his colleagues said that despite an easing of the recession, the economy remains frail enough to keep inflation at bay.
Fed policymakers held a key bank lending rate at a record low of between zero and 0.25 percent and pledged to keep it there for “an extended period” to help brace the economy. The Fed made no new commitment to expand its purchases of government bonds and mortgage securities, to try to drive down rates on consumer debt. That rattled bond investors who fear the prospect of higher interest rates.
But Wall Street zeroed in on the Fed’s new observations about the risks of deflation and inflation.
Fed policymakers dropped language they had used in the statement at their last meeting in April that the weak economy could trigger deflation – a destabilizing and prolonged bout of falling prices and wages. This also spooked bond investors, who took the Fed’s decision not to mention deflation to mean inflation might arise later.
The Fed acknowledged that energy and other commodity prices have risen recently. But policymakers predicted that idle factories and the weak employment market would make it hard for companies to ratchet up prices. The Fed said it expects inflation will “remain subdued for some time.”
The mere mention of higher prices, though, hit the Treasury market because the value of returns on fixed-income investments can erode quickly if inflation occurs. The yield on the benchmark 10-year Treasury note, which moves opposite its price, rose to 3.69 percent from 3.63 percent Tuesday.
Stocks also lost ground after the Fed’s announcement. The Dow Jones, which had been up, closed down 23.05 points.
T.J. Marta, market strategist and founder of Marta on the Markets, a financial research firm, said the Fed’s words “disappoints (inflation) hawks and “angers bond vigilantes.”
Overall, though, Fed policymakers delivered a slightly more encouraging assessment of the economy.
“The Fed is sending the message that the economy is making progress toward a path of recovery, that the credit markets appear to be healing and inflation is not going to be a problem,” said economist Lynn Reaser, vice president of the National Association for Business Economics. “The bogeyman of deflation also was removed from the Fed’s primary risk list.”
The Fed in March launched a $1.2 trillion effort to drive down interest rates to try to revive lending and get Americans to spend more freely again. It said it would spend up to $300 billion to buy long-term government bonds over six months and boost its purchases of mortgage securities. So far, the Fed has bought about $177.5 billion in Treasury bonds.
The Fed is on track to buy up to $1.25 trillion worth of securities issued by Fannie Mae and Freddie Mac by the end of this year. Nearly $456 billion worth of those securities have been purchased.
With signs economic and financial conditions are stabilizing, the Fed is wise to keep a steady-as-she goes course, said Sung Won Sohn, economist at the Martin Smith School of Business at California State University, Channel Islands. The Fed’s actions are “bearing fruit,” he said.
Fed policymakers noted that the “pace of economic contraction is slowing” and that conditions in financial markets have “generally improved in recent months.” Those observations about the recession and financial conditions were stronger than after the Fed’s last meeting in April.
Economists predict the economy is sinking in the April-June quarter but not nearly as much as it had in the prior six months, which marked the worst performance in 50 years. The economy is contracting at a pace of between 1 and 3 percent, according to various projections.
Fed policymakers said its forceful actions, along with President Barack Obama’s stimulus of tax cuts and increased government spending will contribution to a “gradual “return to economic growth.
Bernanke has predicted the recession will end later this year. Some analysts say the economy will start growing again as soon as the July-September quarter.
Fed policymakers noted that consumer spending – the lifeblood of the economy – has shown signs of stabilizing but remains constrained by ongoing job losses, falling home values and hard-to-get credit.
Economists predict the Fed will hold its key banking rates at a record low through this year and into part of next year to spur lending and boost spending Americans. If so, that means commercial banks’ prime lending rate, used to peg rates on home equity loans, certain credit cards and other consumer loans, will stay around 3.25 percent, the lowest in decades.
Even after the recession ends, the recovery is likely to be tepid, which will push unemployment higher.
The nation’s unemployment rate – now at 9.4 percent – is expected to keep climbing into 2010. Acknowledging that the jobless rate is going to climb over 10 percent, President Barack Obama said Tuesday he’s not satisfied with the progress his administration has made on the economy. He defended his recovery package but said the aid must get out faster.
Some analysts say the rate could rise as high as 11 percent by the next summer before it starts to decline. The highest rate since World War II was 10.8 percent at the end of 1982.
The weak economy has put a damper on inflation.
Consumer prices inched up 0.1 percent in May, but are down 1.3 percent over the last 12 months, the weakest annual showing since the 1950s. The Fed suggested companies won’t be in any position to jack up prices given cautious consumers, big production cuts at factories and the weak employment climate.