Fed keeps its foot on the gas

CreditCards.com

The government's chief interest-rate setters are in no mood to unplug the extra juice flowing into the U.S. economy, the Federal Open Market Committee said Wednesday as it concluded its two-day meeting.

As economists widely expected, the committee led by Federal Reserve Chairman Ben Bernanke voted overwhelmingly to continue its robust stimulus measures, in order to give the economy more time to reach a sustained recovery.

The FOMC reiterated its faith in the economic recovery continuing, despite headwinds from Washington.

"Taking into account the extent of federal fiscal retrenchment over the past year, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program as consistent with growing underlying strength in the broader economy," the announcement said.  

Since the committee's last meeting in September, barometers indicate that the economy is continuing its slow limp toward recovery. But the federal government shutdown from Oct. 1-16 cut government paychecks temporarily, and may have left a more permanent mark on consumers' outlook.

"Political gridlock has once again taken a toll on consumer confidence, hitting expectations especially hard," wrote James Marple, senior economist at TD Economics, in a research note. The Conference Board's measure of consumer  optimism fell to 71.2 in October from 80.2 the month before.  And with another potential battle over the federal debt ceiling looming in January, consumers aren't likely to let down their guard for a while. 

Against that backdrop, the FOMC voted to continue buying long-term bonds at its current pace of $85 billion a month. Dubbed "QE2" for the second round of quantitative easing, which began back in November 2010, the purchases of Treasury bonds and housing-backed bonds help keep long-term interest rates low. Analysts expect that, given the continuing uncertainty about the federal budget, the Fed won't cut back on the purchases until sometime during the first quarter of 2014, at the earliest.

For credit card borrowers, the announcement reiterated the status quo on interest rates will hold for quite some time to come.  

Keeper of the punchbowl
The committee also voted to keep short-term rates -- which affect the rates charged on credit card balances -- at their ground-floor levels, with the target for the federal funds rate holding between 0 percent and 0.25 percent.  Any increase in the federal funds rate would boost the prime rate, which is the benchmark used by banks for setting rates on most variable interest rate cards.

Not that anyone's in a rush to put their foot on that particular brake pedal. The committee repeated its previous guidance that it doesn't expect to consider lifting short term rates until unemployment improves to about 6.5 percent or lower, assuming inflation remains tame.  The September reading on joblessness came in at 7.2 percent.

The Fed's job is to pull back the punchbowl just when the party's getting good, but this economy is in more of a recovery ward than a party. Inflation figures released for September showed prices rising at a 1.2 percent rate for the past 12 months, the slowest pace since April. The committee's inflation target is 2 percent, so there is headroom to pump in more stimulus before price hikes begin to become a problem.

Even with interest rates at historically low levels -- the average mortgage rate of 4.13 percent nationally compares to a historical average of 8.6 percent since 1971 -- only A-list borrowers are invited, as lenders shy away from applicants with less-than-pristine credit, said David Liu, portfolio manager for hedge fund TIG Advisors. And while home sales are strong in most markets, home construction is lagging because of the inventory of underwater and foreclosed homes still being worked off.

Despite uncertainty about federal budget fights, some economists predict that the private sector will shrug off worries and continue to keep the economy on a growth path.

"It remains to be seen the extent to which events in Washington, D.C., during October impacted consumer spending," Regions Bank Chief Economist Richard Moody said in an analysis. While spending may see a dip in October, he expects November to compensate. Although surveys of consumer confidence are down, "what matters is what consumers do, not what they say."

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