US keeps key interest rates unchanged

29 Jan 2009

1

Ben BernankeThe US Federal Reserve has decided to keep interest rates  unchanged at 0 to 0.25 per cent to boost economic growth and said it would use "all available tools" to shake-off the slump, and cautioned of a weak economy that was still deteriorating.

The Fed foresees that the current economic situation is likely to necessitate low levels of the federal funds rate for a short time," said the US central bank in a statement.

Although the Fed has exhausted its predictable methods of interest rate cuts, it is resorting to use unconventional tools to lower interest rates to cushion and stabilise the economy.

The Fed said in a statement that it is geared to buy long-term government debt if the situation warrants to improve conditions in private credit markets, but it was not yet equipped to take drastic step as advised by some economists, of outright buying government bonds to infuse more cash into banks.

The Fed said that it would continue to buy large quantities of agency debt and mortgage-backed securities to offer support to the mortgage and housing markets in particular, and is prepared to increase the quantity / period of the purchase plan as the ssituation demanded.

It has already bought billions of dollars of assets including mortgage-backed securities from lenders Freddie Mac and Fannie Mae , as well as commercial paper from several large corporate to sustain their undertakings. (See: Government bail-out for US mortgage giants FannyMae and FreddyMac)

Fed chairman Ben Bernanke said that buying government bonds was a measure of easing credit in markets where lending had stopped, and making banks more willing to lend. This is in contrast to the Japanese government's method of quantitative easing to overcome recession and deflation in late 1990s and early 2000s, where it pumped more reserves into the banking system.

With interest rates at near zero, the likelihood of deflation becomes more of a risk as consumers postpone buying, which suppresses economic activity further.

The Fed acknowledged that information it gathered since the open market committee meet in December indicated that the economy has weakened further and were evaluating options. This move could boost the housing market and reduce outstanding mortgages.

It also said it intends to execute the Term Asset-Backed Securities Loan Facility to smoothen the process of credit to households and small businesses.

The central bank, on its part, will try to keep the size of its own balance sheet at a high level and closely monitor the development in the financial markets.

It also warned that the steep fall in industrial production, set back in the housing industry, jobs being axed daily have resulted in consumers and businesses cutting back on their spending.

It noted that the global demand also appeared to be slowing considerably with some financial markets improving, but the credit crunch squeeze is still affecting households and companies.

Fed expects inflation pressures to remain restrained in near-term due in fall oil prices and other commodities in recent months.

Analyst are of the opinion that Fed will maintain a near zero interest rates through 2009, which is lowest since 1954.

The International Monetary Fund (IMF) yesterday predicted the US economy to contract around 1.6 per cent in 2009, sharply down from its previous estimate of a 0.7 per cent growth.

The US central bank estimates a gradual economic recovery in the last part of 2009, but also warns that the downside risks are significant.

The Fed interest rate announcement came shortly before President Barack Obama's $825-billion economic recovery plan was approved by the US House of Representatives, and now awaits  Senate approval, which may witness an uncertain passage (See: Obama visits Republicans to push relief bill), just as the auto bail out did (See: Senate rejects $14-billion bailout plan for auto majors)

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