Fed to Keep Key Rates at Record Lows Through Mid-2013 Amid Weaker Economy

The Federal Reserve pledged for the first time to keep its benchmark interest rate at a record low at least through mid-2013 to revive a recovery that’s “considerably slower” than anticipated.

The Federal Open Market Committee is “prepared to employ” additional tools to bolster an economy hobbled by weak hiring and anemic household spending, it said in a statement today in Washington.

Three members of the committee dissented, preferring to maintain a previous pledge to keep rates low for an “extended period” without a specific timeframe. Stocks rallied and yields on 10-year Treasury notes briefly touched a record low.

The decision represents the biggest effort since November to spark the U.S. economy and revive confidence while stopping short of initiating a third round of large-scale asset purchases. Chairman Ben S. Bernanke and his colleagues acted after reports showed the economy was slowing and an unprecedented downgrade to the U.S. credit rating sent stocks tumbling from Sydney to New York.

The Fed offered a dimmer view of the economy than it did in the last statement in late June. “Economic growth so far this year has been considerably slower than the committee had expected,” it said. The Fed also said it expects a “somewhat slower pace of recovery over coming quarters.” The “downside risks to the economic outlook have increased,” the Fed concluded.

Spending cuts under a federal debt reduction deal enacted by President Barack Obama on Aug. 2 would start next year and increase into 2013, weighing on economic growth.

Stocks Rise

The Standard & Poor’s 500 Index rose 4.7 percent to 1,172.53 in New York. The yield on the two-year Treasury note fell to 0.196 percent and the 10-year yield dropped to 2.273 percent after hitting a record low of 2.03 percent.

“It’s a dramatic commitment on the funds rate that’s clearly extremely dovish and shows clear bias toward more potential purchases” of assets, said James O’Sullivan, chief economist at MF Global Inc. in New York. “Even this was very controversial -- to have three dissents highlights the real divisions on the Fed right now.”

The Fed left its target for the federal funds rate in a range of zero to 0.25 percent, where it’s been since December 2008. It said it will maintain its policy of reinvesting maturing securities without saying for how long.

Three Dissents

The vote was 7-3. Richard Fisher, president of the Dallas Fed, Charles Plosser of Philadelphia and Narayana Kocherlakota of the Minneapolis Fed all dissented. The last time three FOMC voters dissented was on Nov. 17, 1992, under Bernanke’s predecessor Alan Greenspan.

The Fed’s decision came after Standard & Poor’s unprecedented downgrade of the U.S. credit rating on Aug. 5 sent share prices tumbling on concern a global economic slowdown will deepen. Fitch Ratings and Moody’s Investors Service affirmed their top grades for U.S. debt.

The Standard & Poor’s 500 Index tumbled 6.7 percent yesterday in New York, its biggest decline since December 2008. The drop has wiped out all the gains in stocks since Nov. 3, 2010, when the Fed announced it would buy $600 billion of government bonds, its second round of asset purchases.

Europe’s debt woes added to the market turmoil. Central bankers and finance ministers from the Group of Seven nations pledged Aug. 7 to “take all necessary measures to support financial stability and growth.”

Bond Buying

The next day, the European Central Bank began buying Italian and Spanish bonds in its riskiest attempt yet to battle the continent’s sovereign debt crisis.

While U.S. inflation rates have risen, they are still below the Fed’s informal target range of 1.7 to 2 percent. A measure of consumer-price gains, stripping out food and energy, stood at 1.3 percent for the 12 months ending in June. That’s up from 0.9 percent for the 12 months ending December.

Bernanke told Congress on July 13 that the Fed was prepared to buy more Treasury bonds if the economy appeared in danger of stalling or if the threat of deflation looked like it was going to re-emerge, while repeating his forecast for a pickup in growth in the second half of the year.

Recent economic data have cast doubt on his outlook. Temporary forces such as higher food and energy costs depressing consumer spending, along with supply disruptions from Japan’s earthquake and nuclear disaster in March, which hurt factory production, “appear to account for only some of the recent weakness in economic activity,” the FOMC statement said.

Less Than Forecast

Gross domestic product expanded at a 1.3 percent annual pace in the second quarter, less than forecast by economists, a July 29 government report showed. The economy almost stalled in the prior quarter, growing at a 0.4 percent pace, the weakest three-month period since the recovery began in June 2009.

The same report showed that the recession was about 25 percent deeper than previously estimated, leaving GDP short of its 2007 peak and the economy more vulnerable to another contraction.

Consumers cut spending in June for the first time in almost two years, the Commerce Department said Aug. 2.

“The consumer environment remains very tough,” Michael Polk, chief executive officer of Atlanta-based Newell Rubbermaid Inc., said on a conference call with analysts on July 29. He said a “difficult” U.S. economy was among the reasons the maker of Rubbermaid containers and Sharpie pens had cut its full-year profit and sales forecasts.

‘Flattened Out’

The Fed said there has been “a deterioration in overall labor-market conditions in recent months” and household spending has “flattened out.”

Hiring has slowed as employers lost confidence in the recovery. Average monthly payroll gains fell to 72,000 in the three months through July, from 215,000 in the prior three months. The jobless rate fell to 9.1 percent in July from 9.2 percent in June as Americans gave up looking for work.

“When we have the kind of combination of sub-par growth, stubbornly high unemployment and a big debt overhang, you need low interest rates,” Carmen Reinhart, a senior fellow at the Peterson Institute for International Economics in Washington, said on Aug. 5.

The housing market has also been a drag on growth as sliding home prices cut into consumer confidence and wealth.

Sales of existing homes, the largest portion of the housing market, totaled 4.77 million on an annualized basis in June, a 34 percent drop from their pre-recession peak in September 2005.

Lowest Point

The S&P/Case-Shiller index of property values in 20 cities declined 4.5 percent in May from a year earlier, the most in 18 months, and homeownership at 65.9 percent is at its lowest point since 1998, even as affordability is close to a record high.

“We’re still in a market that is clearly bouncing along the bottom on housing and new construction,” Christopher M. Connor, chief executive officer of Sherwin-Williams Co., said on a July 21 conference call. The Cleveland-based company, the largest U.S. paint maker, also cut its full-year profit forecast because of rising raw material costs.

Manufacturing, which had been one of the few bright spots in the economy, grew in July at its slowest pace in two years, the Institute for Supply Management said on Aug. 1.

To contact the reporter on this story: Jeannine Aversa in Washington at javersa@bloomberg.net; Scott Lanman in Washington at slanman@bloomberg.net.

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net

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