NEW YORK (CNNfn) - The Federal Reserve decided Tuesday to leave interest rates unchanged, but indicated that inflation is still a risk, stoking fears that future rate increases may be in store.|
Analysts had widely expected that the Fed would take no action on interest rates, amid growing signs the U.S. economy is beginning to slow. The Fed's decision marks the central bank's third consecutive policy meeting with no rate hike, following a series of six rate increases since June 1999 that lifted the key federal funds rate by 1.75 percentage points to 6.5 percent.
While the Federal Open Market Committee chose to hold steady on interest rates, the rate-setting panel nevertheless raised the specter of future rate hikes because labor markets remain tight and high energy prices could cause inflation to spiral upward. Crude oil prices recently have surged to 10-year highs, sparking inflation jitters and worries about an abrupt slowdown in growth.
The committee "believes the risks continue to be weighted mainly toward conditions that may generate heightened inflation pressures in the future," the FOMC said in a statement after its Washington meeting.
Financial markets, which traded broadly higher in anticipation of the news, closed mixed following the decision. The Dow Jones industrial average managed to finish up 19 points at 10,719, paring a 140-point gain earlier in the session. The Nasdaq slid into negative territory, down 114 points to 3,454. Bonds also lost ground.
Many investors had hoped Fed Chairman Alan Greenspan and other Fed members would change their tightening bias on interest rates to a "neutral" stance, and perhaps, signal plans to cut rates.
"The economic situation couldn't justify that -- a rate cut," said Milton Ezrati, senior economic strategist at Lord Abbett & Co. "The other thing is we're in the middle of an election cycle and the Fed is loathe to change policy in the middle of an election cycle. They like to be, politically, like Caesar's wife -- above suspicion."
Tuesday's meeting marked the final scheduled FOMC meeting before the Nov. 7 U.S. presidential election. Since 1936, the FOMC has never moved on interest rates at an October meeting during a presidential election year. The policy makers' next meeting is Nov. 15.
The last time the FOMC increased rates was a bold half-point increase in the federal funds rate in May, subsequently leaving rates unchanged at its June and August meetings. The federal funds rate -- which banks charge one another for overnight loans -- remains at 6.5 percent, while the discount rate on Fed loans to banks stands at 6.0 percent.
The Fed's decision to leave interest rates alone comes amid signs that the hot U.S. economy may be losing some steam.
Gross domestic product grew at a fast 5.2 percent in the first half of 2000, but many economists believe that rate will slow during the second half. Retail sales rose a muted 0.2 percent in August, after a sizzling 0.7 percent gain in July, while the U.S. manufacturing sector shrank for the second month in a row in September.
Two economic reports released earlier Tuesday also suggested the economy is slowing. New home sales fell 3 percent in August compared with the prior month, while the Index of Leading Indicators slipped 0.1 percent, the fourth consecutive month of declines.
Fed sees inflation risks
In the FOMC's statement, Fed policy makers said they still see risks in the economy that could trigger an increase in inflation.
"Recent data have indicated that the expansion of aggregate demand has moderated to a pace closer to the enhanced rate of growth of the economy's potential to produce," the committee said. "The more rapid advances in productivity also continue to help contain costs and hold down underlying price pressures."
"However, the utilization of the pool of available workers remains at an unusually high level," the statement continued. "Moreover, the increase in energy prices, though having limited effect on core measures of prices to date, poses a risk of raising inflation expectations."
Economist Diane Swonk, of Bank One, said she believes the Fed is moving toward another rate hike next year.
"We have seen a gradual moving towards a softer tone in their write-ups, even though the threat of balances remain towards inflation," she told CNNfn. "I, in fact, expect the Fed to resume tightening next year, even though I think they will stay out of it for the rest of this year." (243K WAV 243K AIF).
The main issue for the FOMC is oil, and whether high energy prices will take their toll on the rest of the economy, said Bill Sullivan, money market economist at Morgan Stanley Dean Witter.
The Fed "remains a bit more militant than the investment community expected," he said. "They're still vigilant about inflation, they still maintain a bias towards restraint. But most important of all, they're focused in on energy price developments."