Fed Keeps Rate at 5.25%, Abandons Tightening Bias

The Federal Reserve kept the benchmark U.S. interest rate at 5.25 percent and unexpectedly abandoned its tilt toward higher borrowing costs.
By: Craig Torres: Bloomberg.com
``Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth,'' the Federal Open Market Committee said today in Washington. While inflation is the ``predominant'' concern, the statement dropped a reference to ``additional firming,'' language used since June.

Policy makers said recent economic indicators have been ``mixed'' and the ``adjustment'' in the housing industry is continuing. Nevertheless, ``the economy seems likely to continue to expand at a moderate pace over coming quarters.''

The shift suggests officials see a growing risk that the economy, already weakened by a recession in residential real estate, will slow further. Some traders read the change as a signal that the Fed will consider cutting rates by the June policy meeting. Treasury notes and stocks rallied, while the dollar fell.

``It does not appear the committee is prepared to consider easing; rather, they are ruling out tightening,'' said Chris Low, chief economist at FTN Financial in New York. ``The FOMC concedes a decidedly gloomier economic picture in March than in January, but continues to worry'' about inflation.

Uneven Picture

Fed officials are trying to sort through uneven economic data that show continuing strength in employment and persistent inflation pressures alongside a slump in investment spending and rising mortgage delinquencies.

Government reports this month showed unemployment fell to 4.5 percent in February, industrial production gained 1 percent from January and consumer prices rose 2.4 percent from a year ago. Mortgage Bankers Association data show delinquencies on all mortgages at a 3 1/2-year high last quarter.

Today's change in the interest-rate policy tilt likely indicates a downward revision to the Fed's internal forecasts, which are only made public after a five-year lag.

The housing downturn will be ``a major factor in the outlook,'' said David M. Jones, president of DMJ Advisors in Denver, said before the meeting. ``As real growth falls below their forecast toward the end of the year, eventually we will see the Fed leaning toward rate cuts.''

Fed Chairman Ben S. Bernanke is also taking a risk by switching the rate outlook. The labor market is robust, factory output appears to be picking up and inflation is elevated.

The Fed's preferred inflation benchmark -- the personal consumption expenditures price index, minus food and energy -- has been at or above the top of the 1 percent to 2 percent comfort zone of at least six policy makers for about three years. The measure rose 2.3 percent in the 12 months to January.

Watching Housing

Bernanke now needs the data to confirm the softening his staff and other policy makers may be concerned about. Just how far weakness delinquencies in the mortgage markets spread will be one area they will watch.

Housing has subtracted from economic growth for the past five quarters, and lenders could cut back credit as mortgage distress rises.

Mortgage delinquencies rose to a 3 1/2-year high last quarter, the Mortgage Bankers Association said last week. Delinquency rates on subprime mortgages rose to 13.3 percent, the highest since September 2002. Foreclosure rates on all mortgages rose to highest level since the first quarter of 2004.

Uncertainty in economic forecasts is increasing because it's difficult to tell ``how the whole mortgage market is going to turn out,'' David Seiders, chief economist in Washington at the National Association of Homebuilders, said before the meeting.

Company Investment

Business spending in the fourth quarter was also weak. Corporate purchases of equipment and software declined at a 3.2 percent annual rate last quarter, the most since the final three months of 2002. Shipments in January of non-defense capital goods excluding aircraft, a proxy for future investment, slumped 2.7 percent, the most since September 2001.

``The investment side is the most puzzling and the biggest challenge to my optimism,'' James Glassman, senior economist at J.P. Morgan Securities Inc. in New York, said before the announcement. ``The risks have been shifting to the downside.''