Fed upbeat on economy but will keep record rates

[March 15, 2012]  WASHINGTON (AP) -- The job market's gains may endure. Record-low interest rates will, too.

Those signals emerged Tuesday from the Federal Reserve after its latest policy meeting. The Fed sketched a slightly sunnier view than it did in January, when it announced a plan to hold short-term rates near zero through 2014 to help the economy.

Since then, a stream of reports has pointed to a steadily strengthening economy. Employers have added more than a half million jobs. Retail spending has picked up. Even the housing market is stirring.

Yet few expect the Fed to drop its plan to keep short-term rates near zero for nearly three more years. Not anytime soon.

A pullback from that timetable could jolt investors. As long as inflation stays tame, analysts say, the Fed will likely decide to hold rates down if it feels they're still helping the economy.

Mark Zandi, chief economist at Moody's Analytics, said the core question for the Fed isn't whether the economy is strengthening. Rather, it must decide whether the gains might falter, as they have at times since the recession ended in June 2009.

For now, the Fed isn't announcing any new steps to boost the economy. But it isn't ruling them out, either.

"Despite the better economic numbers, the Fed remains very nervous about the economy's prospects," Zandi said. "I would do exactly what the Fed is doing. I would keep all of my options open. Things could go badly wrong."

Some Fed-watchers note that Chairman Ben Bernanke needs to be cautious. Better for him to have underestimated the economy's strength than to have overestimated it. Bernanke can always point later to the Fed's low-rate policies as having worked better than even he expected.

Most of all, the Fed doesn't want to withdraw its help for the economy prematurely

"The Fed is lagging behind the better economic news," said David Jones, chief economist at DMJ Advisors and the author of several books on the central bank. "They are erring on the side of being too pessimistic to be sure that they are providing sufficient support for the economy."

At the same time, Jones said that if the strengthening economy were to ignite runaway inflation, the Fed might have to raise rates much sooner than late 2014 to cool growth. Doing so might fan criticism of the Fed, he said. It could also cause interest rates to jump and stock prices to fall.

"The Fed has almost promised us zero rates through 2014," Jones said. "But if the Fed has to tighten before late 2014, their credibility will be hurt."

In the meantime, the economy is growing stronger. Among the improvements:

• Hiring has brightened. Two jobs reports issued since the Fed's January meeting have been blowouts: Employers added 284,000 jobs in January and 227,000 in February. The unemployment rate has declined to 8.3 percent. The Fed had said in late January that unemployment would likely be 8.2 percent to 8.5 percent by year's end, a forecast that already looks too high.

• Fewer people are being laid off. Weekly applications for unemployment benefits have declined for six months. The four-week average of applications is near a four-year low. That suggests that the job gains will continue.

• Growth in the economy's service sector has accelerated. An index of service-sector activity, covering retailers, hotels and restaurants and information technology companies, has risen twice since the Fed's January meeting.

• The economy is growing faster, and incomes are up. The government said last month that the economy expanded at an annual rate of 3 percent in the final three months of last year, much better than in the previous quarter. It also said incomes rose more in the second half of last year than previously thought. That means more money to spend.

• Consumers are more confident and spending more. Consumer confidence rose last month to its highest level in a year. And retail sales jumped 1.1 percent in February, the biggest increase since September. Figures for the previous two months were revised higher.

• Even homebuilders are more optimistic. An index of homebuilder sentiment rose for the fifth straight month in February to its highest level since May 2007. Builders are becoming more hopeful as they see more prospective home buyers looking at homes.

In its statement after Tuesday's meeting, the Fed policymakers did caution that rising oil and gas prices will raise inflation temporarily. But they said longer-term inflation should remain stable -- repeating a view Bernanke expressed earlier this month.

The statement was approved on a 9-1 vote. Richmond Fed President Jeffrey M. Lacker dissented for the second straight meeting. The statement said Lacker doesn't "anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate through late 2014."

Most economists say any further steps by the Fed, such as another bond buying program to try to drive interest rates even lower to boost the economy, aren't likely soon.

"It would be hard for the Fed to justify more bond-buying now," Paul Ashworth, chief U.S. economist at Capital Economics, said in a note to clients.

Despite the brightening prospects, unemployment remains historically high -- something Bernanke mentioned in testimony to Congress last month, when he said, "The job market remains far from normal."

Bernanke also said consumer spending and confidence remain less than healthy, inflation-adjusted pay gains are low and credit is still tight for many. As long as they are, Bernanke suggested, unemployment might not fall much further.

Low interest rates are intended to encourage consumers and businesses to borrow and spend more. Lower yields also lead some investors to shift money out of bonds and into stocks.

[Associated Press; By MARTIN CRUTSINGER and CHRISTOPHER S. RUGABER]

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