Fed likely to leave rates at lows to aid recovery

August 12, 2009 7:26:54 AM PDT
Signs are growing that an economic recovery may finally be taking shape, but with dangers still lurking, Federal Reserve policymakers are all but certain to leave a key interest rate at record lows to make sure any nascent turnaround gains traction. Fed Chairman Ben Bernanke and his colleagues resumed a two-day meeting Wednesday morning, where they will take fresh stock of the nation's economic and financial conditions. So far, barometers suggest the worst recession since World War II is ending, and that the economy has started to grow again - or will soon.

With the economy turning a corner, the Fed also will weigh whether consumer lending programs intended to ease the recession and stem the financial crisis should be extended.

"I think the Fed will show a bit more confidence in the staying power of the coming economic recovery and indicate that everything is on track," said Mark Zandi, chief economist at Moody's Economy.com.

Still, the Fed has warned that recoveries after financial crises tend to be slow. And dangers remain.

While unemployment dipped to 9.4 percent in July, the Fed says it's likely to top 10 percent this year because companies won't be in a rush to hire. That could restrain the recovery if it crimps spending by already-cautious consumers.

Another risk comes from the troubled commercial real market where defaults on loans are rising. That's a strain on banks holding such loans. The increasing risk is making lenders ever-more stingy about handing out new commercial real-estate loans or refinancing existing ones.

"That's one of the things (Fed policymakers) might want to single out that keeps them worried," said Michael Feroli, economist at JPMorgan Economics.

Against that backdrop, the Fed is widely expected to hold a key bank lending rate at a record low near zero at the meeting's conclusion on Wednesday afternoon. The central bank also is expected to renew a pledge to hold that rate there for an "extended period." It has leeway to do this because the Fed believes inflation will stay low for a while.

Economists predict the Fed will leave its target range for its banking lending rate between zero and 0.25 percent through the rest of this year. The rationale: super-low lending will spur Americans to spend more, which would support the economy.

If the Fed holds its key rate steady, that means commercial banks' prime lending rate, used to peg rates on home equity loans, certain credit cards and other consumer loans, will stay around 3.25 percent, the lowest in decades.

There have been signs the economy is on the mend.

Factory activity is improving. Home sales are starting to pick up, although much of the activity involves people snapping up bargain-priced foreclosed properties. Companies are cutting far fewer workers.

Some financial stresses also are easing, but lending is not flowing normally and financial markets aren't back to full throttle.

Many analysts believe the economy - which logged a mild contraction in the second quarter after a dizzying free-fall in the prior six months - is growing now. That makes it more likely the Fed will consider whether some rescue programs should continue, but any decisions might not come at this week's meeting.

One such program, aimed at driving down interest rates on mortgages and other consumer debt, involves buying U.S. Treasurys. The central bank is on track to buy $300 billion worth of Treasury bonds by late September; it has bought $253 billion so far.

Some economists think the Fed will let the program expire. They say it's not clear whether the program lowered rates. And, there's been concern that the program makes the Fed look like it is printing money to pay for Uncle Sam's exploding budget deficits.

Meanwhile, the Term Asset-Backed Securities Loan Facility is intended to spark lending to consumers and small businesses. It got off to a slow start in March and is slated to shut down at the end of December. Despite the TALF, many people are having trouble getting loans, analysts say. More recently, the program was expanded to provide relief to the commercial real-estate market.

The Fed isn't expected to launch any new revival efforts or change another existing program that aims to push down mortgage rates. In that venture, the Fed is on track to buy $1.25 trillion worth of securities issued by mortgage finance companies Fannie Mae and Freddie Mac by the end of the year. The central bank's recent purchases have totaled about $542.8 billion.

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