Fed to hold interest rates low but must keep watch on inflation
WASHINGTON — Even with the Federal Reserve widely expected to leave interest rates at a record low this week to nurture the fragile recovery, fissures are growing among policymakers about when to start boosting rates to head off inflation.
A shift to higher borrowing costs is probably months away, but Fed Chairman Ben Bernanke and his colleagues likely will privately debate how best to signal a change in stance to investors, businesses and ordinary Americans when they open a two-day meeting today.
At its last meeting in late September, the Fed opted to stretch out into early next year a key program aimed at forcing down mortgage rates. It isn’t expected to veer from that course this week.
Fed policymakers gather as the economy emerges from the worst recession since the 1930s to a much-awaited recovery.
After a record four straight losing quarters, the economy started growing again last quarter, although most of the fuel came from government-supported spending on homes and cars. Despite the turnaround, growth won’t be sufficient to prevent the unemployment rate — now at a 26-year high of 9.8 percent — from rising. Economists predict it will hit 9.9 percent when the government releases the latest snapshot on employment conditions Friday. It’s expected to top 10 percent this year.
Rising unemployment, cautious consumers, tight credit and troubles in the commercial real estate market are among the forces expected to weigh on The recovery going forward.
Against that backdrop, most economists think the Fed on Wednesday will keep the target range for its bank lending rate at zero to 0.25 percent. If it does, commercial banks’ prime lending rate, used to peg rates on home equity loans, certain credit cards and other consumer loans, will stay at about 3.25 percent, the lowest in decades.
Wells Fargo’s chief economist, John Silvia, and other economists also predict Fed policymakers will maintain a pledge to keep rates “exceptionally low” for an “extended period” to make sure the recovery gains traction. The Fed has leeway to do so because inflation thus far has been low, economists said.
Whenever the Fed decides to drop this “extended period” language, it will be taken as a signal that the central bank is preparing to reverse course. Many analysts think the Fed could start to raise rates in the spring or summer.
Given the delicate state of the recovery, Bernanke made clear last month that he’s in no rush to boost rates and reel in the unprecedented amount of money the Fed has plowed into the economy. Other Fed policymakers, however, have suggested that rates might have to go up sooner rather than later.
“If policymakers insist on waiting until the level of real activity has plainly and substantially returned to normal—and the economy has returned to self-sustaining trend growth — they will almost certainly have waited too long,” Fed Governor Kevin Warsh warned in a speech just days after the Fed’s Sept. 22-23 meeting.
It promises to be a high-wire act for the Fed. Boosting rates and removing supports too soon could short circuit the recovery, while holding rates low and keeping supports intact for too long could unleash inflation.
Beyond rates, Fed officials— at their meeting in late September — were conflicted over whether to expand or cut back a program intended to drive down mortgage rates and prop up the housing market, according to minutes of the closed-door deliberations. In the end, Bernanke and his colleagues agreed to slow down the pace of a $1.25 trillion program to buy mortgage securities from Fannie Mae and Freddie Mac. Instead of wrapping up the purchases by the end of this year, the Fed said it would do so by the end of March. So far, the Fed has bought $776 billion of mortgage securities.
The central bank was not divided over another part of the program to buy $200 billion worth of Fannie and Freddie debt. It has bought $141.6 billion so far.
The program has helped to prop up the housing market, but its health remains precarious.
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