Federal Reserve leaves key interest rate unchanged

Associated Press WriterWASHINGTON (AP) -- The Federal Reserve left a key interest rate unchanged Tuesday, allowing Americans to continue to take advantage of some of the lowest borrowing costs in four decades.

That would give consumers an incentive to keep on spending, and businesses might be motivated to step up investment in new equipment and plants. Both are crucial ingredients to help along the budding economic recovery.

Federal Reserve Chairman Alan Greenspan and his colleagues held the federal funds rate -- the interest that banks charge each other on overnight loans -- at 1.75 percent, the lowest level in 40 years. It marked the third consecutive Fed meeting this year that policy-makers decided to hold rates steady.

The decision means the prime lending rate -- a benchmark for many consumer and business loans -- will remain at 4.75 percent, the lowest level since November 1965.

Stocks held on to their gains after the Fed's announcement, rebounding from Monday's sell-off. A quarter-hour after the Fed decision was announced, the Dow Jones industrial average was up 71 points and the Nasdaq index was up 5 points.

Economic growth has been receiving a "considerable upward impetus" from slower inventory liquidation by businesses, the Fed said.

However, the degree of the strengthening in demand by businesses and consumers in the coming quarters "is still uncertain," the Fed said in a statement explaining its decision.

The Fed's decision to leave rates alone comes as the economic recovery, which started out at a sprinter's pace, appears to be slowing to a jog.

The economy broke out of the doldrums in the first quarter, growing at an annual rate of 5.8 percent, its strongest performance in more than two years and confirmation that last year's recession is history. Much of that growth reflected slower inventory liquidation by businesses.

However, many economists believe the economy is growing at a more moderate rate of 3 percent to 3.5 percent in the current quarter. Recent economic reports that showed a slower growth in manufacturing, weaker home sales and construction activity and higher unemployment are consistent with that forecast.

Even with the rebound slowing, economists said they weren't worried that the economy might backslide into a downturn, a "double-dip" recession.

Since the recovery has been spotty and inflation remains under control except for a burst of recent energy price increases, economists expect the Fed to wait at least until August or September to begin raising interest rates.

Just two months ago, many economists, buoyed by forecasts of a sizzling first-quarter growth, were predicting the Fed's first rate increase could come as early as May.

Greenspan recently indicated that the Fed is in no rush to raise interest rates. That means borrowers will have more time to take advantage of low-cost financing, but savers will have to continue to deal with measly returns.

Even though the economy is on the mend, the healing process can be painful.

The nation's unemployment rate shot up to a nearly eight-year high of 6 percent in April and is expected to climb to as high as 6.5 percent.

Making sure that the American shopper, whose spending accounts for two-thirds of all economic activity in the United States, doesn't get spooked by rising unemployment is a key worry. Low interest rates may be the tonic, even if a psychological one, to persuade consumers to keep their pocketbooks and wallets open, analysts said.

Companies whose battered revenues and profits still suffer lingering effects from last year's recession are worried about the recovery's staying power and are reluctant to hire workers back, crank up spending and make other big commitments until they are convinced the turnaround is for real.

The Fed slashed the funds rate 11 times last year to rescue the economy from the clutches of a recession that began in March 2001. The last rate cut came Dec. 11, which pushed the funds rate down to the current 1.75 percent.