Tuesday, August 5, 2008

U.S. Fed leaves interest rate unchanged

The U.S. Federal Reserve Board on Tuesday left its key interest rate unchanged at two per cent, citing improving economic conditions in the United States.

The Federal Reserve decision had been expected by market watchers. The U.S. central bank has kept its key federal funds rate unchanged since April.

U.S. stocks markets reacted to the news favourably as the Dow Jones Industrial and the Standard & Poor's indices both rose more than two per cent.

The Federal Open Market Committee (FOMC) said economic activity has picked up, partly because of past interest rate cuts.

Improved growth has lessened the threat of recession in the U.S., said the FOMC, the group within the Federal Reserve that makes interest rate decisions.

That decreases the pressure on the bank to cut borrowing costs to stimulate the economy.

As well, the Fed said inflation should moderate by the end of 2008 as commodity prices soften.

Slowing price increases reduce the need for the central bank to hike rates to contain inflation.

"There's something in there for everyone," said Art Hogan, chief market strategist at Jefferies & Co., in reaction to the statement.

However, the Federal Reserve said it would keep an eye on prices in case rising oil costs trigger a general hike.

"Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the committee," the FOMC said.

Of the 11 members on the committee, 10 voted in favour of keeping rates at their current level. Only Richard Fisher, known in Fed-watching circles as an interest rate hawk, voted against Tuesday's move.

Fisher wanted to increase interest rates, according to the FOMC.

Recent economic data has been sending mixed signals about whether the United States is in recession or facing a burst of oil-driven inflation. And whether the Fed decides to lower or raise borrowing costs depends upon which of these scenarios the central bank believes most likely.

Depending on the data one looks at, economic indicators show either a weak U.S. economy on the knife's edge of a recession or one coming out of its recent doldrums, analysts say.

Generally, higher interest rates curb economic activity and inflation, while a rate cut boosts the amount of borrowing and spending within a country.

Consumer woes

On Monday, the U.S. Commerce Department reported that Americans spent less in June compared with May, by 0.2 per cent after adjusting for inflation. Oil price hikes were the villain as U.S. drivers paid more at the gas pumps and cut back purchases in other areas.

In addition, spiking energy costs pushed up U.S. inflation 0.8 per cent in the month, the second-largest monthly jump since 1981.

Many Fed experts viewed these figures as indications that the U.S. economy remained in a fragile state and could not sustain an interest rate increase.

On the other hand, U.S. factory orders, often considered a leading indicator for the overall economy, jumped in June, providing evidence that companies see growing demand for their products in the coming months.

Easing inflation

In addition, rising prices, a key concern of the U.S. Fed, appear to be easing.

Oil prices have fallen below $120 US a barrel in recent trading — their lowest level since May and an indication that inflation, driven by rising gas and electricity costs, would start to slow down in August and September.

Canadian economists forecast that the Bank of Canada, facing similarly contradictory figures, likely would follow the U.S. lead and not change interest rates when it meets in September. The Canadian central bank's key rate currently stands at three per cent.



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