November 4, 2009 / 5:52 AM / 8 years ago

Fed sees rates near zero for "extended period"

<p>Traders in the 10-year bond options pit at the Chicago Board of Trade signal orders shortly after the Federal Reserve's decision to leave short-term interest rates untouched between zero and 0.25 percent in Chicago, November 4, 2009.Frank Polich</p>

WASHINGTON (Reuters) - The U.S. Federal Reserve on Wednesday expressed growing confidence that an economic recovery was building, even as it stuck to its commitment to keep borrowing costs near zero for "an extended period."

As expected, the central bank closed out a two-day meeting with a decision to keep benchmark overnight interest rates in a range of zero to 0.25 percent. The vote was unanimous.

In a statement announcing the decision, the Fed said the U.S. economy had "continued to pick up" since its last meeting in September, but it expressed concern the recovery was likely to be muted.

"Household spending appears to be expanding but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit," it said. While still emphasizing risks, the Fed was a bit more upbeat than in September, when it had simply said spending was "stabilizing."

The Fed cut interest rates to near zero last December and has pumped more than $1 trillion into the economy to tame a severe financial crisis and the deepest recession since the 1930s.

Now that the economy is starting to recovery, financial markets are increasingly wondering when the Fed and other central banks around the globe will begin to remove the extraordinary economic support they have provided.

The U.S. central bank was more explicit than it had been previously on why it expects to be able to keep rates "exceptionally low" for a long time, citing the slack that has built up in the economy and the lack of an inflationary threat.

By citing "low rates of resource utilization, subdued inflation trends, and stable inflation expectations," analysts said the Fed was providing a road map to follow to determine when it may finally begin to tighten policy.

Testing the Waters?

In another shift, the Fed said it would buy only about $175 billion of debt issued by government-backed mortgage finance agencies, saying the paper was scarce. It had planned to buy up to $200 billion as part of an effort to keep mortgage costs low.

Some analysts said the Fed may have made the shift to see how markets would respond as a way to inform its thinking about how best to eventually exit its policy support.

U.S. stocks wavered after the Fed's decision, but gave up most of their earlier gains by the end of the day, with the broad S&P 500 index closing up only marginally.

<p>Traders in the 10-year bond options pit at the Chicago Board of Trade signal orders shortly after the Federal Reserve's decision to leave short-term interest rates untouched between zero and 0.25 percent in Chicago, November 4, 2009.Frank Polich</p>

Prices for U.S. government debt fell on worries about massive debt supply in the coming days, while interest rate futures turned higher as traders cut bets the Fed would soon step back from its easy money policy. The U.S. dollar weakened.

"If there is any surprise, it sounds like there is not even any hint that they are going to raise rates soon," said Robert MacIntosh, chief economist at Eaton Vance Corp in Boston. "We've got a number of Fed meetings to go before we will get any kind of increase."

Top Fed officials, including Chairman Ben Bernanke, have said the U.S. recession has left a legacy of high unemployment and idle factories that should keep price pressures in check.

A private report on Wednesday showing U.S. companies cut payrolls at the slowest pace in more than a year may add to a sense that the economic numbers are moving in the right direction.

Slideshow (2 Images)

But even as the government on Friday is expected to report that employers are cutting fewer jobs, the jobless rate is forecast to rise to a fresh 26-year high of 9.9 percent and unemployment is expected to keep climbing into next year.

The world's largest economy grew at a faster-than-expected 3.5 percent annual rate in the third quarter, which effectively signaled the end of the downturn.

Suggesting further momentum, data on Monday showed manufacturing activity hit its highest level in 3-1/2 years last month, though a report on Wednesday showed the nation's vast services sector was growing only modestly.

Wrestling With an Exit

But even with prominent investors such as billionaire Warren Buffett on demonstrating faith in the economy -- with his Berkshire Hathaway Inc company's deal this week to purchase the nation's largest rail company saying it is poised to benefit from the recovery.

The banking system is still under pressure from loan losses, and credit remains tight.

Most analysts at top U.S. banks have been expecting the Fed to keep interest rates on hold until mid-2010 or later. Before it raises rates, it is expected to begin to withdraw some of the cash it pumped into the economy to keep credit flowing.

Other central banks are also wrestling with how best to spur economic growth and when to withdraw extraordinary measures to support their economies.

The European Central Bank is expected to keep rates on hold at a record-low 1.0 percent on Thursday, while there is a good chance the Bank of England will expand its large asset purchase program at a meeting the same day.

Additional reporting by Pedro Nicolaci da Costa, David Lawder and Emily Kaiser; writing by Mark Felsenthal and Emily Kaiser; editing by Tim Ahmann and Leslie Adler

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