Fed holds key short-term rate steady

WASHINGTON -- The Federal Reserve held a key short-term interest rate at a 45-year low Tuesday amid scattered signs that the economy, after months of stubborn listlessness, is perking up.

Fed chairman Alan Greenspan and his Federal Open Market Committee colleagues -- the group that sets interest rate policy in the United States -- kept the federal funds rate at 1 percent. The funds rate is the interest banks charge each other on overnight loans and is the Fed's primary tool for influencing economic activity.

The decision was unanimous.

The Fed said that currently low short-term interest rates, coupled with still-robust productivity gains are "providing important ongoing support to economic activity." The committee also said that since the Fed's last meeting on June 25 spending is taking hold, although labor market indicators are mixed.

Holding the funds rate steady means that commercial banks' prime lending rate for many short-term consumer and business loans will remain at 4 percent, the lowest level since 1959. The funds rate and the prime rate move in lockstep and were last lowered on June 25.

At that time, the Fed pared the funds rate by one-quarter percentage point, marking the 13th cut since January 2001, when the central bank's credit-easing campaign began.

Rates on longer-term loans, however, rose after the Fed's June 25 action. Disappointment on Wall Street that the Federal Reserve didn't make a bolder cut to short-term rates pushed bond rates up, which caused long-term mortgage rates to rise. More recent signs that the economy is gaining traction also contributed to rising rates.

Rising mortgage rates have slowed refinancing activity, an important force underpinning consumer spending. Economists, however, are hopeful that larger paychecks and other incentives coming from Bush's latest tax cut will move in to support spending as refinancing cools.

The Fed's decision Tuesday to hold the funds rate steady comes as private economists believe the economy, which limped through the first six months of this year, will gain speed in the last half. Some are estimating that growth in the last six months will clock in at an annual rate of 3.5 percent to 4 percent or more.

Economists said they believe Fed policy-makers will leave the funds rate at 1 percent at their next meeting on Sept. 16 and probably through the rest of this year.

"They want to be more assured that faster growth takes hold and that the economy comfortably moves on to a faster track," said Lynn Reaser, chief economist at Banc of America Capital Management.

Fed policy-makers repeated concerns Tuesday that while the risk of an economically dangerous slide in prices, or deflation, is remote, they must remain alert because of its potential to wreck the economy. With the Fed more concerned about inflation going down, rather than up, the central bank has leeway to hold the funds rate at currently low levels for a while, Reaser said.

"In these circumstances, the committee believes that policy accommodation can be maintained for a considerable period," the Fed said in its statement.

Near rock-bottom short-term interest rates, with Bush's third round of tax cuts, should motivate consumers and businesses to spend and invest more, thus strengthening economic growth in the second half, economists said.

There have been promising signs lately. A report from the Institute for Supply Management this month showed that manufacturing activity expanded in July for the first time in five months, further evidence that this part of the economy is on the mend. Manufacturing has had a more difficult recovery from the 2001 recession than any other sector.

Last week, the nation's largest retailers reported strong sales for July, a promising sign for consumer spending, which has been a key force keeping the economy moving.

Especially encouraging to economists, however, were some budding signs in the government's recent report on second-quarter gross domestic product that business investment may be coming back to life.

Businesses, which cut spending on equipment and software in the first three months of this year, boosted such investment in the second quarter at a sizable 7.5 percent rate. That marked the biggest increase in three years. A sustained turnaround in capital investment by businesses is a crucial ingredient to the economy's ability to fully rebound, economists said.

Even if the economy does that in the second half, the job market is likely to remain sluggish, economists said. The nation's unemployment rate dipped to 6.2 percent in July, mainly because many people left the civilian work force. Businesses cut jobs for the sixth month in a row. Business will want to be certain about the recovery's vigor before going on a hiring spree, economists said.