Fed keeps rates steady again, waits for stronger economic recovery
By Jeremy M. Simon | Published: September 23, 2009
The Federal Reserve once again left interest rates unchanged, as the central bank waits for the economic recovery to strengthen before taking up the battle against inflation.
That decision came at the conclusion of a two-day meeting, with Fed officials voting unanimously to leave its federal funds rate at a range of 0 percent to 0.25 percent, keeping the prime rate at 3.25. Variable rate credit cards -- which account for the majority of plastic -- have annual percentage rates that are set using the prime rate.
The Fed led off its post-meeting statement in an upbeat fashion. "Information received since the Federal Open Market Committee met in August suggests that economic activity has picked up following its severe downturn," the statement says. "Conditions in financial markets have improved further, and activity in the housing sector has increased."
However, they added that the strength of the recovery isn't enough to warrant interest rate hikes. "The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent," the statement says, "and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period."
The last change to the federal funds rate came in December 2008; as long as the Fed sees inflation as remaining subdued, it will leave the federal funds rate alone and will not be the cause of credit card rate changes.
The Fed's latest phrasing mirrors its cautious approach to monetary policy. "It's an uncomfortable point to start talking about tightening monetary policy until economic growth starts to pick up," says George Mokrzan, senior economist with Huntington Bancorp in Columbus, Ohio.
Threading a needle
Analysts emphasize the Fed's tricky position -- caught between raising rates too soon, which could damage the economic recovery, and leaving rates unchanged for too long, which could allow inflationary pressures to build. "The Fed is trying to thread a needle here," says Tony Plath, professor of finance at the University of North Carolina at Charlotte. He explains that while inflation eventually will become a pressing concern, central bankers are currently more fearful of a so-called "double-dip recession" -- in which a brief uptick in the economy is quickly followed by another move downward.
Mokrzan agrees that the central bank has a challenge on its hands. "The Federal Reserve is in a difficult and unusual position," he says.
The Fed is trying to thread a needle here.
|-- Tony Plath
Plath points out that before becoming Fed chairman, Ben Bernanke's academic work supported the argument that the central bank removed stimulus too soon during the Great Depression. Plath predicts Bernanke won't repeat what he sees as a mistake by his predecessors, and the Fed will continue to wait until the threat of a double dip has passed before boosting interest rates. "If they make a mistake, they're going to keep stimulus in place too long," Plath says.
Plath says the Fed may tighten monetary policy by raising rates in March or April of next year. However, he adds that if we see a strong Christmas, a rate hike could come sooner. But that robust holiday season looks doubtful. "How are you going to have much of a Christmas when 26 million are un- or underemployed?" Plath says.
Banks begin to lend, consumers begin to borrow
Meanwhile, inflation won't be the Fed's primary concern until the economic recovery is undoubtedly under way, analysts say, and that will require participation from both banks and borrowers.
That combination could take hold in 2010. By next year, Mokrzan expects things will look better. "Not only will consumers be more willing to take on added debt, but the credit market will be more capable of supplying that debt," he says. He notes that consumers' willingness to take on debt, alongside increased purchases of large durable goods -- for example, major home appliances -- and more housing activity will signal that change is here to stay.
At that point, the Fed will need to take action to limit inflation alongside a growing economy. "When we see lending in the banking industry, the risk of inflation improves tremendously," Plath says.
Even if the Fed leaves rates unchanged, credit cardholders could still experience rising annual percentage rates. As banks try to make money ahead of a credit card reform law that takes full effect next year, most borrowers can expect to pay more. Still, analysts say there is an exception for banks' most desired customers: borrowers with high credit scores who make more than the minimum monthly payments and carry a balance less than 30 percent of their line of credit. If that segment of the borrowing public sees an APR increase, they can look for a lower interest rate with another bank, Plath says.
Meanwhile, "the rest of us are likely to see rate increases between now and next spring," he says.
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