Fed Holds Rates Steady Amid Soft Economy

By Glenn Somerville

WASHINGTON (Reuters) -

The Federal Reserve (news - web sites) kept U.S. interest rates steady at four-decade lows as expected on Tuesday, saving its ammunition for 2003 as it waits to see whether the economy can emerge from a "soft spot."

The unanimous decision by the U.S. central bank's Federal Open Market Committee (news - web sites) leaves the trend-setting federal funds rate at 1.25 percent, the level it hit after the Fed slashed borrowing costs by a bold half percentage point in November.

"The limited number of incoming economic indicators since the November meeting, taken together, are not inconsistent with the economy working its way through its current soft spot," the Fed said in a statement after the meeting that added little new to the assessment offered last month.

Policymakers also maintained their characterization of the risks faced by the economy as being evenly balanced between rising prices and a renewed downturn. That was the position policymakers adopted last month when they cut rates and it was seen as a signal of steady rates for some time ahead.

Stock markets and the U.S. dollar were little moved by the decision. Treasury bonds sold off a little but then retraced their moves.

The Fed choice to hold its fire comes as no surprise given lingering uncertainty about possible war with Iraq and with the Bush administration's reshuffling of its economic team as it prepares a fresh economic stimulus plan.

Recent economic data has offered a mixed picture of the economy's prospects. The national unemployment rate unexpectedly rose to 6 percent in November, while a report on Tuesday said sales at U.S. chain stores faltered last week.

But a separate report on Tuesday showed October wholesale inventories fell for the first time in half a year -- a promising sign since it means new orders may pick up since warehouses must be restocked to keep up with demand.

Fed policymakers said in November they believed the economy was going through a weak patch and that, with the cut, interest rates were low enough after 11 interest rate cuts in 2001 and one this year to keep growth going.

There was some support for that idea in the latest survey from Blue Chip economic forecasters, a closely watched poll of top economists, which said fourth-quarter gross domestic product growth was likely to drop to a lackluster 1.4 percent annual rate from 4 percent in the fourth quarter, but to gradually accelerate in 2003.

With the Bush administration moving forward on a program of tax cuts and other stimulus measures, expected to be presented to Congress in January, economic activity may get an additional jolt from the extra cash in consumer wallets.

Treasury Secretary Paul O'Neill was forced out last week along with senior White House economic adviser Lawrence Lindsey in a sign of the White House's determination to get a stimulus package through Congress and working well before the 2004 presidential election campaign. Bush named O'Neill's replacement, rail executive John Snow, on Monday.

O'Neill was seen as lukewarm to fresh tax cuts out of concern for pushing budget deficits higher and had maintained the economy was on track for a gradual recovery.

Snow echoed President Bush (news - web sites)'s dissatisfaction with economic growth and declared himself ready to pursue a "pro-growth, pro-jobs agenda" at his nomination ceremony on Monday, using terms that are generally considered to imply an imminent push for lower taxes.

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