Fed Leaves Rates Unchanged, but Sees Improving Climate

The Federal Reserve's policymaking committee held its key federal funds rate target steady at 1.25 percent, a 41-year low, Wednesday, with the hope that will spur more spending and investment by consumers and businesses and help lift the economy out of the doldrums.

The vote was unanimous. The funds rate is the interest banks charge each other on overnight loans and is the Fed's primary tool for influencing economic activity.

The Fed said that rising oil prices and geopolitical risks -- a reference to a possible war with Iraq -- have restrained spending and hiring by businesses.

However, "as those risks lift, as most analysts expect, the accommodative stance of monetary policy, coupled with ongoing growth in productivity, will provide support to an improving economic climate over time," the Fed said in a statement following its first meeting of this year.

Holding the funds rate steady means that commercial banks' prime lending rate -- the benchmark for many consumer loans -- will also remain at 4.25 percent, the lowest level since May 1959.

Both the funds rate and the prime rate, which move in lockstep, were pushed down to their currently low levels in November when the central bank decided to slash the funds rate by a bold half a percentage point, marking its first and only rate reduction in 2002.

War worries, anxious consumers and a jittery job market were reasons enough for the Fed to keep short-term interest rates at decades-low levels in the months ahead, economists say.

Fed policy-makers have said repeatedly that currently low interest rates should help support the economy as it works its way through what they call a "soft spot."

Leaving borrowing costs low may motivate consumers to keep on spending and businesses to step up investment during these muddled economic times, something that would bolster economic growth, economists say.

"The economy is in a state of suspended animation," said economist Ken Mayland, president of ClearView Economics. "Business decisions and maybe even some consumer buying decisions are being put on hold as they wait to see what is going to happen with a possible war with Iraq and how it will turn out."

The economy has been struggling mightily to get back to sure footing after being pummeled by the 2001 recession. It grew at a respectable 4 percent rate in the third quarter of 2002, but probably slowed sharply in the final three months of last year, with economists predicting a growth rate of just 0.9 percent when final figures are compiled. The government will report Thursday on how the economy performed in the fourth quarter.

With the aim of energizing the economy, President Bush has offered a 10-year, $674 billion tax-cut proposal.

"Lower taxes and greater investment will help this economy expand," Bush said in his State of the Union speech Tuesday night. "More jobs mean more taxpayers and higher revenues to our government."

Democrats have their own smaller-scale plans.

Economists believe the funds rate could stay at 1.25 percent at least through the summer.

The Fed lowered interest rates 12 times starting in January 2001, with the last rate cut coming in November 2002, the only rate reduction of that year. Economists said it takes time for the full power of all of those rate reductions to show up in the economy.

Fed policy-makers will be waiting to see that "the economy really has solid traction and that could turn out to be the second half of the year before that is clearly evident," said Tim O'Neill, chief economist at Bank of Montreal.

If the country goes to war with Iraq and the United States scores a quick win, then the Fed will probably stay on the sidelines for a while and possibly raise rates in the early fall, economists said. But if a war dragged on or produced a big rise in energy prices, there's the chance the Fed might cut rates.

"Iraq is the biggest risk to the economy," said Lynn Reaser, chief economist at Bank of America Capital Management.

Reuters and the Associated Press contributed to this report.