Falling oil prices help convince the Federal Reserve not to raise interest rates
The Federal Reserve left interest rates unchanged on Aug. 5, and rate-setters made clear that they take the risk of a worsening economic slowdown every bit as seriously as they take the risk of inflation. Only one voter on the Federal Open Market Committee dissented from the opinion, saying he wanted an immediate rate increase in the federal funds rate from its current level of 2%. That was Richard Fisher, president of the Federal Reserve Bank of Dallas.
The Fed's statement accompanying its decision was "marginally more dovish" about inflation than the statement after its last meeting on June 25, said Julian Jessop, chief international economist of Capital Economics, in an instant analysis. Jessop noted that "there was no repeat of the suggestion that the downside risks to growth 'appear to have diminished somewhat,'" which appeared in the June statement. No wonder, given that the credit crunch is still dragging on and the economy lost another 51,000 jobs in July.
Financial markets liked the Fed's statement as well as the fact that only one committee member dissented from it. The Standard & Poor's 500-stock index, which had already been up 1.8% before the 2:15 p.m. ET announcement, climbed higher afterward and closed at 1284.86, a 2.87% increase. The Dow Jones industrial average was up 331.62, or 2.94%, to 11,615.77.
The sharp fall in energy prices in recent weeks probably helped convince the Fed not to raise rates. Crude oil—the most important commodity in the world economy—fell to $120.10 a barrel on Aug. 5, off more than a dollar, after sinking as low as $118. Oil is still by no means cheap, but it's 17% lower than its all-time high of $145.18 on July 3. In his analysis, Jessop noted that the Fed's June statement referred to "continued increases" in energy prices, while the Aug. 5 statement said energy prices are simply "elevated."
Juggling Inflation, Growth, and Finance Risk
If the economy weren't so weak, the Fed would probably be raising interest rates vigorously to stem inflation. The Consumer Price Index rose 4.9% in the 12 months ended in June, fueled by higher food and energy prices. Noting those pressures, the Fed said, "Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee."
Scott Anderson, senior economist at Wells Fargo (WFC), said in a statement, "The Fed, like a soldier under fire, remains hunkered down in its foxhole for the time being."
Anderson said that the Fed's effort to do three things at once—keep prices stable, keep the economy growing, and avoid a financial catastrophe—makes it hard to tell what the Fed will do next.
Indeed, one economist said he thought the Fed's statement was slightly more hawkish than the last one. Harm Bandholz, economist at UniCredit Markets & Investment Banking, noted in an analysis that while the statement reiterated that the "Committee expects inflation to moderate later this year and next year," it said this outlook remains "highly uncertain."