Fed report: Economy showing modest improvement

The Federal Reserve said the U.S. economy continues to show signs of modest improvement but signaled it will stay the course and keep interest rates low to help spur a recovery.

As expected, the central bank left its key interest rate, the federal funds rate, near 0%, the level it has been at since December 2008. That rate is used as a benchmark for a broad range of business and consumer loans. In a statement released at the end of its two-day meeting, the Fed pointed to improvement in business spending, but said that the “recovery is likely to be moderate for a time.” While that may not sound like a ringing endorsement of economic growth, it was significantly better than what the Fed had been saying in its statements since last April — “Economic activity is likely to remain weak for a time.” Still, the Fed repeated its earlier forecast that conditions are “likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

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But one member, Kansas City Fed President Thomas Hoenig, voted against the Fed’s latest action. According to the statement, Hoenig thought that economic conditions had changed enough so that the continued expectation of low rates was “no longer warranted.” It was the first dissenting vote among Fed policymakers since January 2009. The Fed said it will stick with plans to let some of its efforts of the past two years expire in the coming months. But it provided no new details of how or when it plans to start pulling back on nearly $2 trillion it has pumped into the economy over the last two years through the purchases of mortgages, long-term Treasurys and the debt of mortgage finance firms Fannie Mae (FNM) and Freddie Mac (FRE).

Some critics of the Fed have worried that the central bank is behind the curve in withdrawing that stimulus, which could feed inflation down the road. But the Fed repeated its earlier view that it believes inflation “is likely to be subdued for some time.” Bruce McCain, chief investment strategist at Key Private Bank, said Hoenig’s dissent is probably a good thing since it may assure markets that the Fed is not getting too far behind the curve in keeping prices in check. Keith Hembre, chief economist at First American Funds, said if the Fed policymakers had followed Hoenig’s lead and dropped the language on keeping rates exceptionally low, it would have roiled financial markets not yet ready for the Fed to start raising rates.

“Hoeing is one of the more hawkish guys on inflation,” Hembre said. “But I think the view [of other Fed policymakers] on inflation is on the mark.” Hembre added that due to the weakness in the job market, he thinks it will be years before there is a big enough increase in wages that could help drive the prices of goods and services higher. Along those lines, the central bank did highlight some key economic weaknesses that remain, including tight credit, continued declines in real estate investment and employers still being reluctant to hire new staff. McCain said that given the uneven signs of improvement in the housing market so far, it was not realistic to expect the Fed to lay out plans to start selling the $1.25 trillion in mortgages it expects to own by the end of March. Some have even argued the Fed should raise that limit in order to buy more mortgages.

“There is concern about what happens with the housing market when there is no longer the support of the Fed making these purchases,” McCain said. He believes the Fed has decided its best course on mortgages is to “steer the middle course,” and go ahead with the purchases it has committed to and no further. The Fed’s latest meeting comes two days before the Commerce Department is expected to report the U.S. economy grew at an annual rate of 4.6% in the fourth quarter. That would be its strongest pace in four years. The meeting also comes as the Senate prepares for a key vote Thursday that could clear the way towards confirming Fed chairman Ben Bernanke for another four-year term as head of the central bank. His term is set to expire Sunday, and there has been growing opposition from both ends of the political spectrum to his reappointment.

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