Fed leaves rates steady but hints at future easing

The Federal Reserve yesterday left its key short-term interest rate unchanged but signalled concern about a weakening US economy and hinted at a possible future easing of monetary policy.

Keeping its target for the federal funds rate, the main overnight lending rate between banks, at a 40-year low of 1.75 per cent, the US central bank's open market committee said policy "should foster an improving business climate".

The decision disappointed investors hoping for a cut to shore up growth, and the Fed's downbeat assessment of the economy offered little comfort to investors already worried the economy might dip back into recession.

"Obviously, the market always looks favorably on lower rates, but in this case the Fed is saying there are risks there for more economic weakness," said Mark Donahoe, managing director of institutional sales trading at U.S. Bancorp Piper Jaffray.

The Dow Jones industrial average slumped 206.5 points, or 2.38 percent, to 8,482.39, while the broader Standard & Poor's 500 Index fell 19.6 points, or 2.17 percent, to 884.20, according to the latest data. The technology-laced Nasdaq Composite Index tumbled 37.57 points, or 2.87 percent, to 1,269.27.

But in a sign that it shares spreading fears that the recovery may peter out, the Fed shifted its so-called "tilt" of policy towards concern about economic weakness, a move interpreted by financial markets as hinting at a possible rate cut to come.

"The softening in the growth of aggregate demand that emerged this spring has been prolonged in large measure by weakness in financial markets and heightened uncertainty related to problems in corporate reporting and governance," the committee said.

The central bank's decision came against a backdrop of growing fears in financial markets about the durability of the US economic recovery.

After a relatively short and shallow recession in 2001, US economic activity rebounded at the turn of this year. But recent figures have suggested the recovery lost momentum in spring and early summer. In the three months to June gross domestic product grew at an annual rate of just 1.1 per cent.

Last month Mr Alan Greenspan, the Federal Reserve chairman, expressed confidence that the economy would gradually gather steam over the next year, but that was before the publication of data that showed the economy much weaker than had previously been thought early in the year.

In addition the sharp falls in stock prices since the start of this year have undermined Americans' wealth and dented consumer confidence.

In recent weeks these difficulties have been compounded by financial problems for companies, as interest rates on corporate bond yields have climbed.

Against that, the housing market, the main driver of consumer wealth for the last few years, has remained strong.

Although the Fed has left short-term interest rates unchanged since last December, longer-term rates have dropped sharply in the last five months and more Americans than ever are taking advantage of low rates to refinance their mortgages and increase their spending power.

Zero-percent financing on purchases of many consumer durables has also helped keep consumption growing.

- (Financial Times Service)