Fed Shift Indicates Main Rate Will Stay at 2% to Revive Economy

By Scott Lanman

Aug. 6 (Bloomberg) -- Federal Reserve policy makers indicated that interest rates won't budge until next year as they wait for the credit crisis to abate and inflation to ease.

The central bank, which left its benchmark rate at 2 percent yesterday, said ``downside risks to growth remain,'' dropping a reference in June's statement to ``diminished'' dangers. The Fed also said price increases are of ``significant concern.''

The tweaks to the Federal Open Market Committee's statement signal that Chairman Ben S. Bernanke and his team want to avoid an early rate increase that further weakens employment and fuels instability in financial markets, economists said.

``They don't want to rock boats,'' said former Fed governor Lyle Gramley, now senior economic adviser at Stanford Group Co. in Washington. ``They want to remind people that their concern for inflation is genuine, but they have no intention of doing anything about it right away.''

The Fed's statement spurred the biggest jump in the Standard & Poor's 500 Index since April. Traders reduced bets the Fed will tighten at the next two meetings in September and October. The chance of an increase by the end of October fell to 45 percent from 53 percent, based on futures prices.

``Bottom line is, they're not going to change rates anytime soon, so they went out of their way to minimize changes to the statement,'' said Stephen Stanley, chief economist at RBS Greenwich Capital Markets in Greenwich, Connecticut. ``They're trying to create as few waves as possible. They're not going to be doing anything this year, so they'd just as soon not have people speculate about their moves.''

`Nay' Vote

The 10-1 decision included one dissent in favor of higher rates, from Dallas Fed President Richard Fisher, who cast his fifth straight ``nay'' vote this year.

``The statement was put together with an intent to get the fewest number of dissents as possible,'' said Diane Swonk, chief economist at Chicago-based Mesirow Financial Inc. ``Many of the Fed presidents view inflation differently than the Fed governors. The divisions are pretty deep and it is hard to get a consensus statement because there isn't a consensus.''

Before the decision, some economists said Minneapolis Fed President Gary Stern and Philadelphia's Charles Plosser may also dissent after both last month discussed the need to raise rates. They may have voted to approve the rate decision and statement in part because of the Fed's comment that inflation was of ``significant concern,'' some economists said.

The last time three policy makers dissented was Nov. 17, 1992. All 14 dissents under Bernanke have come from regional-bank presidents, not the governors who have permanent votes.

Inflation Risks

In the last decision, on June 25, the FOMC statement said risks to inflation and inflation expectations had ``increased.''

Since then, a government report showed consumer prices surged 5 percent in the 12 months through June, the biggest jump since 1991. Still, crude oil has dropped 19 percent from a record $147.27 a barrel on July 11, a decline the Fed acknowledged yesterday by referring to ``earlier increases'' in energy prices, compared with ``continued increases'' in the June statement.

The FOMC reiterated concern yesterday about the economy, saying ``tight'' borrowing conditions, the housing recession and ``elevated energy prices'' will probably restrain growth for a few quarters, the Fed said.

Fed officials are betting that lower oil prices will cool inflation, while the interest-rate cuts over the past year will eventually help revive growth, said Neal Soss, chief economist at Credit Suisse in New York,

``You put that in the stew, and there's nothing to do,'' said Soss who used to work as an aide to former Fed Chairman Paul Volcker. ``Patience can be a virtue.''

Another Tweak

In another tweak to the statement, Fed officials added ``over time'' to their judgment that ``substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.''

U.S. employers' payrolls have declined for seven straight months for a total of 463,000 jobs, with the unemployment rate rising in July to 5.7 percent, the highest in more than four years. Residential investment has subtracted from GDP for 10 consecutive quarters, while an index of home prices in 20 metropolitan areas fell 15.8 percent in May.

Even with yesterday's stock rally, the S&P index is down 18 percent from its October record. The premium for three-month interbank loans over a measure of the overnight rate, another gauge of financial-market health watched by the Fed, has failed to improve since June.

The market turmoil prompted Bernanke and his colleagues last month to extend the Fed's emergency-lending programs for Wall Street firms through January.

Central bankers will wait to raise interest rates until the economy is on ``better footing,'' said Allen Sinai, chief economist at Decision Economics Inc.

``What we have now is artificially low interest rates,'' Sinai said. ``You overdose the patient to get them on their feet, and then you have to withdraw the overdose.''

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net