Fed Keeps Rate at 5.25%, Abandons Tightening Bias

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http://www.bloomberg.com/apps/news?p...zQo&refer=home

By Craig Torres

March 21 (Bloomberg) -- The Federal Reserve kept the benchmark U.S. interest rate at 5.25 percent and unexpectedly abandoned its tilt toward higher borrowing costs.

``Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth,'' the Federal Open Market Committee said today in Washington. While inflation is ``elevated'' and the ``predominant'' concern, the statement dropped a reference to ``additional firming,'' language used since June, the last time the Fed lifted rates.

Policy makers said recent economic indicators have been ``mixed'' and acknowledged the persistent downturn in housing. Nevertheless, they repeated that ``the economy seems likely to continue to expand at a moderate pace over coming quarters.''

Bonds and stocks rallied as some traders read the change as a signal that the Fed will consider cutting rates by the June policy meeting. Other economists said the new wording doesn't necessarily mean a reduction is imminent.

``It does not appear the committee is prepared to consider easing; rather, they are ruling out tightening,'' said Chris Low, chief economist at FTN Financial in New York. ``The FOMC concedes a decidedly gloomier economic picture in March than in January, but continues to worry'' about inflation.

Uneven Picture

Fed officials are trying to sort through uneven economic data that show continuing strength in employment and persistent inflation pressures alongside a slump in investment spending and rising mortgage delinquencies.

Government reports this month showed unemployment fell to 4.5 percent in February, industrial production gained 1 percent from January and consumer prices rose 2.4 percent from a year ago. Mortgage Bankers Association data show delinquencies on all mortgages at a 3 1/2-year high last quarter.

Today's change in the policy preference likely indicates a downward revision to the Fed's internal forecasts, which are only made public after a five-year lag.

``This economy is almost at stall speed now,'' said Paul Kasriel, director of economic research at Northern Trust Securities in Chicago and a former Fed economist. ``They are getting a little more concerned about the real economic outlook as a result of the housing slump. It is not just housing, but spillover into other parts of the economy.''

Fed Chairman Ben S. Bernanke is also taking a risk by switching the rate outlook. The labor market is robust, factory output is picking up and inflation is elevated.

The Fed's preferred inflation benchmark -- the personal consumption expenditures price index, minus food and energy -- has been at or above the top of the 1 percent to 2 percent comfort zone of at least six policy makers for about three years. The measure rose 2.3 percent in the 12 months to January.

Watching Housing

Bernanke now needs the data to confirm the softening his staff and other policy makers may be concerned about. Just how far weakness delinquencies in the mortgage markets spread will be one area they will watch.

Housing has subtracted from economic growth for the past five quarters, and lenders could cut back credit as mortgage distress rises.

The Mortgage Bankers Association said last week that delinquency rates on subprime mortgages rose to 13.3 percent, the highest since September 2002. Foreclosure rates on all mortgages rose to highest level since the first quarter of 2004.

Company Investment

Business spending in the fourth quarter was also weak. Corporate purchases of equipment and software declined at a 3.2 percent annual rate last quarter, the most since the final three months of 2002. Shipments in January of non-defense capital goods excluding aircraft, a proxy for future investment, slumped 2.7 percent, the most since September 2001.

``The Fed is neutral with respect to their inclination to tighten or relax their monetary policy,'' said Robert Gay, managing director at Fenwick Advisers LLC in Rye, New York and a former Fed economist. In the economy, there's `` enough evidence of sub-par performance for the Fed to ease their tightening bias.''