THE BASIS POINT

FOMC Keeps Fed Funds At 2%, Discount Rate At 2.25% (Full Statement & Analysis)

 

Following their June 24-25 meeting today, the Federal Open Market Committee kept the Fed Funds Rate at 2% and the Discount Rate at 2.25%, and said that “uncertainty about the inflation outlook remains high,” and “upside risks to inflation and inflation expectations have increased.” This is a slight shift from their April 30 meeting where they implied weak economic activity and inflationary threats (in energy and commodity prices) may offset each other. Interest rate markets were neutral on the news, holding on to the rate increases priced in during the 2 week period leading up to today’s FOMC announcement. The full FOMC statement is below.

From September 2007 to April 2008, the Fed cut the bank-to-bank Fed Funds Rate 3.25% (from 5.25% to 2.0%), and cut the Fed-to-bank Discount Rate 4.0% (from 6.25% to 2.25%). This is the first pause since that cut cycle.

Inflation is being driven by economic stimulus checks being spent and record high gas prices, but the housing market weakness continues to make the consumer weaker. This is a balancing act for the FOMC, and one FOMC member Richard Fisher, voted against the hold and preferred a hike because he believes that inflation is more of a threat than economic weakness. If you factor in inflation, Fed Rates are 0% or negative, so Fisher does have a valid reason for his vote. Another FOMC inflation hawk Charles Plosser also voted against the April rate cut, but this time he voted to hold.

For a briefing on why rate cuts can cause even more inflation, see this story.

The Discount Rate means that commercial banks can get 28 day loans from the Fed at 2.25%, which makes it a viable way to access funds amidst the continuing credit crunch — it’s also important to note, that until further notice, investment banks can also access the Discount Window in addition to commercial banks. And instead of being limited to 28 day loans, both entities can get loans up to six months if they meet certain underwriting requirements. These measures have been implemented by the Fed in recent months to help credit markets. The hold on Fed Funds Rates means Home Equity Line of Credit 2nd mortgages will remain at 5% plus margin — all HELOCs are the Prime Rate plus a base rate (which is called a margin), and Prime is Fed Funds Rate + 3%.

FULL FED STATEMENT
The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent.

Recent information indicates that overall economic activity continues to expand, partly reflecting some firming in household spending. However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and the rise in energy prices are likely to weigh on economic growth over the next few quarters.

The Committee expects inflation to moderate later this year and next year. However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high.

The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time. Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Voting against was Richard W. Fisher, who preferred an increase in the target for the federal funds rate at this meeting.

 

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