AP
Fed Expected to Leave Rates Unchanged
Tuesday August 7, 3:28 am ET
By Martin Crutsinger, AP Economics Writer
Federal Reserve Expected to Once Again Leave Interest Rates Unchanged

WASHINGTON (AP) -- While Wall Street has been on a wild roller-coaster ride and housing troubles continue to mount, the Federal Reserve still seems to be most concerned about inflation.

For that reason, most economists believe Fed Chairman Ben Bernanke and his colleagues will keep interest rates unchanged for a ninth consecutive time when they wrap up their meeting Tuesday.

That would mean that the federal funds rate will remain at 5.25 percent, where it has been for more than a year. It would also mean that the prime lending rate, the benchmark for millions of consumer and business loans, will remain unchanged at 8.25 percent.

Both rates have remained at that level since June 2006 when the Fed raised the funds rate for a record-setting 17th consecutive time, capping a two-year campaign to push rates high enough to slow the economy and keep inflation under control.

While there is a widespread belief that the central bank is not going to change interest rates, there is plenty of debate among economists over how the Fed will acknowledge the recent market turmoil, which has reflected spreading worries about credit quality, especially in such areas as subprime mortgages, loans offered to borrowers with weak credit histories.

That market turmoil has resulted in some wild days on Wall Street. The Dow Jones industrial average surged by 286 points on Monday, its biggest one-day gain this year, but that followed a 281-point loss on Friday. The Dow is down 3.8 percent after closing above 14,000 for the first time on July 19.

Some analysts believe the Fed will acknowledge the market's worries and stress that if the credit problems become serious enough it stands ready to supply extra cash to the banking system.

"I think they will comment on the lending crisis," said David Jones, chief economist at DMJ Advisors. "They need to say that the Fed is prepared to deal with any liquidity difficulties in the credit market."

While the Fed serves as the banking industry's lender of last resort, providing money to financial institutions when other sources of credit are difficult to obtain, other analysts said they were not sure the central bank would have much to say about the current credit problems.

"It might make investors nervous if all of a sudden the Fed is elevating the importance of what is going on in financial markets," said Mark Zandi, chief economist at Moody's Economy.com. "The Fed has argued for some time that risks were improperly priced. To bail investors out at the first sign of losses would be a mistake that would just engender more risk-taking in the future."

Other analysts said the central bank will say little about credit troubles because it is unclear how much impact they will have on the overall economy.

"The fewer words the better," said Diane Swonk, chief economist at Mesirow Financial in Chicago. "They don't want to signal anything yet because things are up in the air."

At the moment, the economy is sending mixed signals. Overall economic growth, after slowing to a barely perceptible annual rate of 0.6 percent in the first three months of the year, rebounded to a healthy pace of 3.4 percent in the April-June quarter.

However, analysts don't think that growth rate is sustainable in the face of the severe slump in housing and the spreading credit problems, which have affected not only borrowers trying to buy houses but also corporations trying to borrow money. Many economists believe growth will slow to around 2.5 percent in the second half of this year and unemployment will creep up to around 5 percent. It edged up to 4.6 percent in July after holding at 4.5 percent for the past three months.

Investors, who are hoping that slowing economic growth and rising unemployment will prompt the Fed to start cutting interest rates by the end of this year, note that the economic slowdown is having the desired effect of lowering inflation pressures.

A price index closely watched by the Fed which excludes energy and food rose by 1.9 percent for the 12 months ending in June, inside the central bank's comfort zone of 1 percent to 2 percent.

But analysts said they believe inflation will have to remain low for some time before the central bank decides to cut rates. For that reason, many are forecasting that rates could stay unchanged for the rest of this year and into 2008.

Federal Reserve: http://www.federalreserve.gov