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For Fed, Keeping Rates Steady Is the Easy Part

Reuters
Monday, 4 Aug 2008 | 8:01 PM ET

Wall Street widely expects the U.S. Federal Reserve to keep short-term benchmark interest rates unchanged Tuesday as the central bank grapples with a faltering economy, shaky financial system and higher prices.

While the federal funds rate will likely stay at 2 percent, more than one voting member of the rate-setting Federal Open Market Committee policy-makers may dissent and call for higher rates.

The Federal Reserve headquarters in Washington, DC.
The Federal Reserve headquarters in Washington, DC.

The Fed held rates steady when the panel last met in June. It last eased in April, bringing the fed funds rate down by a cumulative 3.25 percentage points from mid-September last year.

A Reuters poll on Friday showed most primary dealers expected the Fed to hold rates steady through the end of the year, with the next move likely to be a rate increase sometime next year.

Following are some factors policy-makers are considering:

Economy

The U.S. unemployment rate rose to 5.7 percent in July, its highest in more than four years, as employers cut payrolls by 51,000 nonfarm jobs, the seventh straight month of declines.

The U.S. economy grew 1.9 percent in the second quarter, as consumer spending was bolstered by the government's tax rebate checks. Gross domestic product for the final quarter of 2007 was revised to show contraction of 0.2 percent.

U.S. manufacturing was flat in July, with the Institute for Supply Management index of national factory activity at 50.0 from 50.2 in June, above economists' median forecast of 49.3.

Durable goods orders, excluding volatile transportation orders, were up 2 percent in June, the sharpest rise since December.

The Reuters/University of Michigan Surveys of Consumer's July final consumer sentiment index rose to 61.2 from June's final reading of 56.4. One-year inflation expectations stood unchanged at 5.1 percent in July while 5-year inflation was at 3.2 percent versus 3.4.

Financial Institutions/Central Bank Steps

Concerns about the U.S. financial system flared again in July. The government formed a bailout plan for U.S. mortgage finance companies Fannie Maeand Freddie Mac , with the Treasury extending credit to the firms if needed and the Fed allowing the firms to borrow directly from the central bank after they had tapped funding from the Treasury.

Ahead of the Fed
What to expect from the Fed, with Brian Bethune, Global Insight and Julia Cornado, Barclays Capital

Banks' financial woes were highlighted by another wave of write-downs. Merrill Lynch reported a $5.7 billion write-down and sold $8.5 billion in stock.

U.S. commercial banks' primary credit borrowings rose to a record $16.38 billion per day in the week ended July 23.

(Watch a preview of the issues facing the Fed in accompanying video.)

On July 30, the Fed announced measures to enhance its liquidity provisions, including an extension of letting primary dealers borrow directly from the Fed through next January, a move that was widely anticipated.

Inflation

The consumer price index rose 1.1 percent in June while it was up 5 percent from a year ago. Core CPI, which excludes volatile food and energy prices, was up 0.3 percent from the previous month and 2.4 percent from a year earlier. U.S. crude oil futures prices hit a record $147.27 per barrel on July 11.

The price index for personal consumption expenditures was 4.2 percent for the second quarter, and 2.1 percent when food and energy costs were excluded.

Housing

Housing starts rose a surprising 9.1 percent in June mainly due to a change in New York City building codes that if ignored would have seen starts decrease by 4 percent.

Total existing home sales fell 2.6 percent in June to a 4.86 million-unit annual rate.

New home sales fell 0.6 percent to a 530,000 annual pace in June.

Prices of U.S. single-family homes fell 0.9 percent in May from a month earlier, or down 15.8 percent from a year earlier which was a record fall.

U.S. construction spending fell a steeper-than-expected 0.4 percent in June after the prior month was revised higher, as private home building touched its lowest rate in nearly seven years.

Recent Comments

Fed Chairman Ben Bernanke, July 15: "The possibility of higher energy prices, tighter credit conditions and a still-deeper contraction in housing markets all represent significant downside risks to the outlook for growth. At the same time, upside risks to the inflation outlook have intensified lately."

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