The Fed Left Interest Rates Unchanged Tuesday

The Federal Open Market Committee decided on Tuesday, August 05, 2008, to keep its target for the federal funds rate charged on overnight loans between banks at 2 percent, pointing to continued uncertainty about inflation amid renewed concern over economic weakness. "Although downside risks to growth remain, the upside risks to inflation are also of significant concern," the Fed said.


Economic activity expanded in the second quarter, partly reflecting growth in consumer spending and exports. However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and elevated energy prices are likely to weigh on economic growth over the next few quarters.

The consumer price index rose 5 percent in June from a year earlier, a 17-year high. Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities, and some indicators of inflation expectations have been elevated. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

The Fed cut interest rates aggressively over the past year, from 5.25 percent last September, and launched numerous direct-loan programs for financial institutions, with the hope of offsetting the credit strains and boosting the economy. But the moves have only partially improved conditions in key lending markets.

Rates for a 30-year fixed mortgage, for instance, are higher than they were a year ago as banks tighten their standards and mortgage giants Fannie Mae and Freddie Mac struggle through market turmoil. The higher costs and decline in mortgage availability are threatening to exacerbate the housing downturn. Tumbling home values could restrain consumer spending even further.

At the same time, banks are facing steep losses from mortgages. Their weaker state means they will have less capital to lend to consumers and businesses to help them out of the economic slowdown.

The renewed market turmoil, from the crisis over Fannie and Freddie to the waves of fear in financial markets, is weighing on some Fed officials and raising doubts about a quick turnaround for the economy.

The Fed is currently trying to juggle three balls in the air at the same time: maintain price stability, promote an environment conducive to economic growth and rescue the financial system from catastrophic failure. This leaves the direction and timing of future interest rate changes highly uncertain.