Fed Will Keep Rates Low, Money Flowing to Banks

The Federal Reserve, acknowledging the economy has continued to deteriorate, signaled Wednesday that it will keep using unconventional tools to cushion the fallout, including keeping a key interest rate at a record low for quite "some time."


The Fed agreed—with one dissent—to keep the targeted range for the federal funds rate between zero and 0.25 percent. The funds rate is the interest banks charge each other on overnight loans.

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Economists predict the Fed will leave rates at that range through the rest of this year.

"The economy has weakened futher," the Fed said. To provide support, it said it would keep rates at rock bottom levels for "some time."

Having taken the unprecedented step of slashing its key rate to record lows at its previous meeting in December, the central bank pledged anew to look to other unconventional ways to revive the economy.

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Specifically, the Fed said it is now "prepared" to buy longer-term Treasury securities if the circumstances warrant such action.

"As expected, the study on buying longer-term Treasury paper is completed," said Ram Bhagavatula, managing director at Combinatorics Capital. "Now they will buy it if needed. But with all the programs in place to buy risky assets, I don't think it will be needed in the near-term."

Fed Chairman Ben Bernanke and his colleagues are battling a three-headed economic monster: crises in housing, credit and financial markets that—taken togheter—haven't been seen since the 1930s.

Despite the Fed's aggressive rate-cutting campaign, a string of bold Fed programs and a $700 billion financial bailout program run by the Treasury Department, credit and financial markets are still stressed and far from normal.

"The Fed's bearish comments on the economy and inflation still took us by surprise," said Christopher Rupkey, economist at Bank of Tokyo-Mitsubishi. "The Fed is obviously concerned that this recession is going to last longer than the two 16 month recessions of the 70s and 80s.

Rupkey also picked up on the deflationary subtext in the FOMC statement, adding, "Longer and deeper recessions have deflationary risks and the Fed said as much today when they said there is some chance inflation could be lower than the rate that would best enable the economy to grow at its potential rate."

At its last meeting in mid-December, the U.S. central bank reduced its target for the benchmark overnight federal funds rate to zero to 0.25 percent, and said rates would likely stay unusually low for some time.

That surprise move to lower its target for the benchmark federal funds rate from one percent put the Fed in uncharted territory. Financial markets had expected the Fed to lower rates by no more than three-quarters of a point, to 0.25 percent.

In its statement at the time, the Fed underscored its commitment to use extraordinary measures, including using its balance sheet to support the credit markets.

The Fed has flooded markets with dollars, more than doubling the size of its balance sheet to more than $2 trillion, and it may shed more light on how it plans to support broken down credit markets in its statement Wednesday. Investors are particularly keen to see whether the Fed signals a willingness to begin buying long-dated U.S. government debt.