Federal Reserve to keep rates low through 2013

The U.S. Federal Reserve takes the unprecedented step of promising to keep interest rates low until 2013 as it tries to bolster a flagging U.S. economy.

Internal dissent at Fed over statement

The Federal Reserve building is seen in Washington. (Charles Dharapak/Associated Press)

The U.S. Federal Reserve took the unprecedented step Tuesday of promising to keep interest rates low until 2013, trying to assure investors that it will act as needed to bolster the flagging U.S. economy.

In a statement released following its regularly scheduled meeting on monetary policy, the central bank departed from its practice of using the expressions "exceptionally low" levels for an "extended period," in pledging to keep its target for the federal funds rate where it is, without spelling out exactly how long "extended" might be.

The wording was opposed by three members of the Fed's monetary policy committee — Richard W. Fisher, Narayana Kocherlakota and Charles I. Plosser — because of fears it could boost inflation.

The Fed also said economic recovery has been "considerably slower" than it expected after its meeting in June and that "risks to the economic outlook have increased."

The statement held out the promise of low rates on mortgages and other consumer loans longer than many had assumed.

The central bank already has kept its key interest rate close to zero since 2008.

Fed 'very nervous' about economy

Fed officials "are very nervous about the economy," said Mark Zandi, chief economist at Moody's Analytics. "This is unprecedented for the Fed to indicate they are ready to keep rates low for two more years."

Some economists said the Fed didn't offer any remedies for the deteriorating economic conditions it described.

University of Oregon economist Timothy Duy called the clearer language about how long rates would stay low "weak medicine." He wanted the Fed to commit to buying more Treasury bonds.

The central bank announced a $600-billion US program a year ago to increase the supply of money in the American economy. That supported stock markets around the world but it expired in June.

As markets dissected the statement and its view of a slowing economy and the message of low interest rates for two years, they reacted first with a gain, then pared those gains before finishing with a blistering rally.

Investors bought the perceived safety of U.S. Treasurys, pushing the yield on the 10-year note briefly down to a record low of 2.03 per cent before heading higher. Yields and prices on debt instruments move in opposite directions.

Stocks have tumbled, especially over the previous three sessions, as traders worried about the effects of the U.S. credit downgrade, Europe's debt crisis and mounting expectations of a global recession.

A downgrade of U.S. government debt by Standard and Poor's last Friday deepened investor anxiety and sent indexes plummeting on Monday, with the TSX falling 491 points, leaving the main index down almost 20 per cent from its highs of early March, although North American markets rebounded sharply on Tuesday.

On Monday, the Dow Jones industrial average suffered its sixth-worst point drop in history, falling 634.76 points.

Canadian rates may now be on hold

The Bank of Canada had been expected by some to start raising interest rates in September, but is now expected to keep them on hold.

BMO deputy chief economist Doug Porter said the the bank will likely keep its key overnight rate target at one per cent well into next year.

Until the recent turmoil, Porter said, he thought the Canadian central bank would start raising interest rates this fall with two quarter-point rate hikes by the end of the year.

"In fact, because of the weakness in equities there has been some talk recently that there is even a remote possibility the Bank of Canada could cut rates in the coming weeks or months," Porter said.

"I still think that's a long shot, but at the very least events have conspired to keep the Bank of Canada on the sidelines for a lot longer than most had anticipated as recently as a few weeks ago."

With files from The Canadian Press and The Associated Press