Fed Leaves Rate at 5.25%, Says Inflation Slowing

(Bloomberg) -- The Federal Reserve kept the benchmark U.S. interest rate at 5.25 percent, declaring that inflation is slowing ``modestly'' even as the economy picks up speed.
The Fed's statement, which dropped language that described inflation as elevated, triggered a rally in stocks and bonds as investors concluded the central bank will keep rates unchanged for at least six months. The new wording overshadowed the Fed's retention of its bias toward tightening credit.
``Recent indicators have suggested somewhat firmer economic growth, and some tentative signs of stabilization have appeared in the housing market,'' the Federal Open Market Committee said today in a statement in Washington. ``Overall, the economy seems likely to expand at a moderate pace over coming quarters.''
The reputation of Ben S. Bernanke, who became chairman a year ago tomorrow, was burnished by government figures today that showed economic growth rebounded last quarter and a measure of inflation eased. The reception contrasts with the skepticism that greeted last month's Fed statement, when some economists predicted a slump in housing and manufacturing would require imminent rate cuts.
``Readings on core inflation have improved modestly in recent months, and inflation pressures seem likely to moderate over time,'' the Fed said. ``However, the high level of resource utilization has the potential to sustain inflation pressures.''
The Dow Jones Industrial Average advanced 98.3 points, or 0.8 percent, to 12,621.69. The yield on the benchmark 10-year Treasury note declined 6 basis points to 4.81 percent.
`Changed Their Footing'
``It's nice that they have changed their footing a little bit,'' said Paul R.T. Johnson, chief executive officer of Boston Cabot in Chicago. ``Maybe we can have good economic growth with low inflation.''
Today's unanimous vote extends the Fed's period of inactivity to seven months, the longest stretch without a change since June 2004, when the Fed ended a yearlong freeze at 1 percent. Policy makers, who next meet March 20-21, are counting on the economy slowing enough to reduce inflation.
``Some inflation risks remain,'' the Fed said. ``The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.''
The Fed's preferred inflation gauge, which excludes food and energy costs, rose at a 2.1 percent annual pace in the fourth quarter, the Commerce Department said today.
It's the fifth straight period the measure has exceeded 2 percent, the upper end of the comfort range articulated by Bernanke, who testifies before Congress Feb. 14-15 on monetary policy and the economy. The gauge rose at a 2.2 percent pace in the third quarter.
Comparison
The retention of the Fed's tightening bias contrasts with some forecasts made a month ago, when indications of a potentially deeper slowdown raised the possibility that the Fed could alter its stance. At the last gathering, several FOMC members saw increased risks of slower economic growth, according to meeting minutes.
Since then, economic reports showing job gains, consumer spending, signs of stabilization in the housing market and a narrower trade deficit have all but erased that possibility.
Investors are increasingly coming around to that view. Traders see little chance of a rate cut by the end of August. At the start of December, futures contracts reflected an almost- certain cut by the end of March.
``As long as the economic data remains as constructive as it has been lately, the Fed will be happy to keep policy as it stands,'' said David Resler, chief economist at Nomura Securities International Inc. in New York.
Fed members, as part of an ongoing discussion on how much information to disclose publicly, were scheduled this week to ``consider the role that economic projections and forecasts can play in communicating information,'' the Dec. 12 minutes said.
Brighter Picture
The Commerce Department confirmed the economic trend today, giving its initial estimate that fourth-quarter gross domestic product expanded at a 3.5 percent annual pace, compared with 2 percent in the third quarter and 2.6 percent in the April-to-June period.
Policy makers who spoke this month gave little indication they were ready to adjust borrowing costs. San Francisco Fed President Janet Yellen said Jan. 17 that the existing stance was ``well-positioned'' to bring down inflation without hurting growth; Poole used the same phrase in a press conference that day.
``It will still take some additional time for inflation to unwind due to lags between policy actions and their impacts on economic activity and inflation,'' Yellen said in a speech in Scottsdale, Arizona, which she repeated five days later in Nevada.
Fed Vice Chairman Donald Kohn said in a Jan. 8 speech that ``despite the recent favorable price data, I believe it is still too early to relax our concerns about whether the run-up in price pressures in the spring and summer of last year is truly unwinding and whether it is unwinding rapidly enough to forestall a pickup in inflation expectations.''
To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net .