- The Washington Times - Thursday, June 25, 2009

The Federal Reserve signaled no change in its zero-interest rate policies after a two-day meeting Wednesday, but offered a slightly more upbeat assessment of the prospects for recovery from recession.

“The pace of economic contraction is slowing,” the Fed’s Open Market Committee said. “Conditions in financial markets have generally improved in recent months. Household spending has shown further signs of stabilizing.”

But the Fed said deep problems continue to hold back growth in the economy. Consumers remain “constrained by ongoing job losses, lower housing wealth and tight credit,” while “businesses are cutting back on fixed investment and staffing.”

The Fed concluded that it must keep short-term interest rates at their historically low levels because “economic activity is likely to remain weak for a time.”

Inflation remains subdued, although oil and other commodity prices “have risen of late,” the Fed noted.

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Nevertheless, out of concern about triggering inflation fears in the financial markets, the Fed chose not to expand its program for purchasing mortgage bonds and Treasury bonds, which was created early this year in an effort to draw down long-term interest rates that are not directly controlled by the central bank.

Worries about a revival of inflation after the economy recovers have helped drive up mortgage rates and Treasury yields by nearly a full point in recent weeks, erasing the dramatic reduction in rates the Fed had achieved with its purchasing program at the beginning of the year.

Some investors worry that the program makes the Fed appear to be essentially printing money to help finance the burgeoning national debt, thus it had become counterproductive for the Fed to pursue it.

“Injecting additional money into the banking system is a pretty dangerous game right now, and the Fed cannot afford to press on the accelerator amid a potentially inflationary environment,” said Richard Yamarone, economist at Argus Research Corp.

While some investors are placing bets that rising inflation will force the Fed to reverse course and raise interest rates as soon as early 2010, Mr. Yamarone said that remains unlikely as long as the economy is extremely weak.

“The Fed faces a difficult balancing act between rising inflation and a cooling economy,” he said. “They will have to reside in a wait-and-see mode until the economic and financial picture becomes clearer.”

There was little reaction in financial markets, which largely anticipated the Fed’s moves.

Before the Fed’s announcement, mixed news about the economy came from the Census Bureau. It reported that new home sales declined 0.6 percent last month, but orders for big-ticket goods at factories jumped a surprisingly strong 1.8 percent after a similar rise in April. The rate of orders growth in the last three months was over 5 percent, compared with a 50 percent drop at the end of last year.

The improvement was led by orders for machinery, computers and electronics. Analysts said factories appear to be gearing up in response to two developments: China’s robust infrastructure building program is reviving exports for machinery, while the depletion of stocks of goods at American businesses has prompted many to order new goods for sale.

“New orders are up, up but not away,” said Harm Bandholz, economist at Unicredit Markets. He noted that despite the uptick in orders, shipments of finished goods from factories continue to slow, reflecting the lingering weakness in the economy.

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