Fed holds rates and warns on deflation

The Federal Reserve yesterday left US short-term interest rates at a 45-year low and indicated a rise in rates could still be some months off. It also renewed the warning that excessively low inflation (i.e. deflation) was on balance the biggest worry over the future course of the economy.

The widely expected outcome of this latest meeting of the policy-making Federal Open Market Committee leaves the central bank's target federal funds rate for overnight money at 1 per cent, its lowest level since 1958.

Economists generally believe the next move in rates will be upward. But in the closely watched statement accompanying the rates decision the FOMC made clear its neutral bias may continue for some while, despite signs that US economic growth is picking up.

It said the upside and downside risks were "roughly equal", but the predominant factor was "the risk of an unacceptably low rate of inflation". In addition, the committee noted, "while spending is firming, the labour market has been weakening".

Though the economy is expected to grow at a fairly robust 3.5 per cent or more for the rest of the year, the recovery is not creating new jobs. Manufacturing shed a further 93,000 jobs in August, even though the headline unemployment rate edged down from 6.2 per cent to 6.1 per cent. Along with Iraq, the economy is the biggest threat to President George Bush's re-election next year. Since he entered the White House in January 2001, almost 3 million jobs have been lost. He thus risks running for re-election as the first US president since Herbert Hoover to have seen a net loss of jobs during his term of office. The trend reflects not only a stagnant economy, but sharply rising productivity and the transfer of US manufacturing to low-wage producers such as China.