Fed to keep rates low to support weak recovery

[June 23, 2010]  WASHINGTON (AP) -- To sustain the fragile economic rebound, the Federal Reserve is sure to leave interest rates at record lows and is likely to repeat a pledge to keep them there for a while.

The Fed ends a two-day meeting Wednesday with policymakers having cause for optimism as well as caution. The economy has been growing again for nearly a year. Manufacturing activity is picking up. Businesses are spending more. And Fed Chairman Ben Bernanke has expressed confidence that the nation won't fall back into a "double dip" recession.

At the same time, the recovery remains vulnerable to threats: Europe's debt crisis, an edgy Wall Street, cautious consumers, a fragile housing market and high unemployment.

"The effect of European developments on the U.S. economy is likely to be modest, so we expect the tone will be cautious but certainly not dire," said Michael Feroli, economist at JPMorgan Chase Bank.

The Fed is certain to leave its key bank lending rate at between zero and 0.25 percent. The rate has remained at that level since December 2008.

That means rates on certain credit cards, home equity loans, some adjustable-rate mortgages and other consumer loans will remain low. Commercial banks' prime lending rate would stay at about 3.25 percent, the lowest point in decades.

Ultra-low rates serve borrowers who qualify for loans and are willing to take on more debt. But they hurt savers. Low rates are especially hard on people living on fixed incomes who are earning scant returns on their savings.

Still, if rock-bottom rates spur Americans to spend more, they would help energize the economy. That's why the Fed also is expected to maintain its pledge, in place for more than a year, to keep rates at record lows for an "extended period."

Dropping or weakening the extended-period language would spook Wall Street and businesses and could crimp hiring, analysts said. "It is not the right thing to do now," said Kurt Karl, chief U.S. economist at Swiss Re. "You don't want to derail employment growth."

In fact, given the risks to the recovery both at home and overseas, economists increasingly say the Fed probably won't start boosting rates until next year -- or possibly into 2012. That's a change from a few months ago, when economists thought the Fed would begin raising rates at the end of this year.

The Fed has leeway to hold rates at record lows because inflation is essentially nonexistent.

Still, some inside the Fed who worry that easy money could spur inflation are already uneasy. One of them, Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, has dissented for three straight meetings from the Fed's decision to retain the "extended period" pledge.

Besides inflation, Hoenig has said he fears keeping rates too low for too long could lead to excessive risk-taking by investors, feeding speculative bubbles in the prices of assets like stocks, bonds and commodities.

After suffering the worst recession since the 1930s, the economy has been growing for about a year. Yet the pace hasn't been robust enough to drive down unemployment, now at 9.7 percent. The rate is expected to stay high through this year and next. As a result, consumers have been cautious about spending. In May, retail spending fell by the largest amount in eight months.

Surveying the situation, Capital Economics in a note to clients concluded: "Interest rate hikes still years away."

[Associated Press; By JEANNINE AVERSA]

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