Federal Reserve keeps rate unchanged at 2%

The Federal Reserve left its main interest rate at 2 per cent, rebuffing calls by some investors for a cut after Lehman Brothers Holdings Inc’s bankruptcy shook markets worldwide.

“Downside risks to growth and the upside risk to inflation are both of significant concern,” the Federal Open Market Committee said in a statement in Washington. “The committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.”

Chairman Ben S Bernanke and his colleagues signalled they will continue to address market turmoil with emergency lending and aim monetary policy at a longer-term economic forecast that may still show the economy skirting a recession.

 

“Tight credit conditions, the ongoing housing contraction, and some slowing in export growth are likely to weigh on economic growth over the next few quarters,” the statement said. “Over time, the substantial easing of monetary policy combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.”

The decision was unanimous, the first such agreement in a year.

“The committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain,” the Fed said.

New York Fed President Timothy Geithner didn't come to Washington today for the meeting, staying in New York, where talks continue at his bank on the crisis at American International Group Inc

Futures Bets: Futures traders had put an 80-per cent chance on at least a quarter-point rate cut. Three months ago, they saw a 100 per cent chance of an increase.

The Fed held rates steady even after the Standard & Poor’s 500 Index dropped 4.7 per cent yesterday to the lowest level since October 2005. Rate cuts totaling 3.25 percentage points in the past year and emergency Fed loan programmes have failed to revive lending among banks.

“We have a very concentrated problem in housing that’s not really a rate problem, and we’ve got a financial crisis that's really not a rate problem,” former Dallas Fed President Robert McTeer said in an interview with Bloomberg Radio before the decision. “I don't think we have a generally weak economy that needs lower rates.”

Wall Street Upheaval: Bernanke and Treasury Secretary Henry Paulson refused to offer federal aid to Lehman after its stock plunged last week, pushing the 158-year-old company into bankruptcy early yesterday.

Merrill Lynch & Co became engulfed by the turmoil, agreeing to a quick merger with Bank of America Corp this week, while insurer AIG struggled to stave off collapse after its credit ratings were cut.

The rout sparked by the collapse of the US sub-prime mortgage market has cost financial institutions worldwide $515 billion in writedowns and losses since the start of 2007. Firms have raised $362 billion of capital in response.

The New York Fed injected $70 billion of temporary reserves into the banking system today and $70 billion yesterday, the most since the September 2001 terrorist attacks. The central bank has also provided billions of dollars through direct loans of cash and Treasuries, and widened on Sept 14 widened the collateral accepted for loans to securities firms to include equities.

Credit-Market Seizure: Still, banks are driving up short-term lending rates on concern AIG will follow Lehman into bankruptcy and leave financial institutions with losses on $441 billion of credit derivatives issued by the biggest US insurer. Central banks around the world pumped more than $210 billion into the financial system as they sought to alleviate the credit-market seizure.

The cost of borrowing in dollars overnight more than doubled to the highest since 2001. The overnight dollar rate soared 3.33 percentage points to 6.44 per cent today, its biggest jump in at least seven years, according to the British Bankers’ Association. The rate was as low as 2.07 per cent in June.

Tumbling commodity prices, including a 38 per cent decline in crude oil from a July 11 peak, ease pressure on the Fed to fight against inflation. The consumer price index fell 0.1 per cent in August, the Labour Department said today. So-called core prices, which exclude food and energy, rose 0.2 per cent after a 0.3 per cent gain in July.

Impeding Growth: Lehman’s bankruptcy filing came amid signs that losses at financial institutions are impeding US economic growth.

The economy will slow to a 1.2 per cent annual growth rate, or less than half the prior quarter’s pace, as consumer spending, the biggest part of the economy, stalls this quarter, according to a Bloomberg survey from Sept 2 to Sept 9.

The decline in consumer spending prompted automakers last month to reduce car output by 12 per cent, or the most in a decade, Fed figures showed yesterday. Industrial production in the US fell by 1.1 per cent, or the most in almost three years.

Unemployment rose to a five-year high of 6.1 per cent in August and foreclosure filings rose to a record as falling home prices frustrated homeowners’ efforts to sell or refinance their homes, RealtyTrac Inc. said.