Fed Holds Rates Steady, Signals Willingness to Act

WASHINGTON – Federal Reserve (search) officials opted Tuesday to hold interest rates at 1958 lows — but changed the language of their statement to indicate that a rate hike may happen sooner than later, although it said the move would come at a "measured" pace.

Fed Chairman Alan Greenspan (search) and the rate-setting Federal Open Market Committee (search) formally abandoned its contention that deflation was a risk, preparing markets for the first rate rise in four years — but without specifying when higher borrowing costs may come.

The central bank's policy panel said risks to prices were balanced between a pickup and a potential slowing in inflation and dropped a pledge to be patient on policy.

"At this juncture, with inflation low and resource use slack, the committee believes that policy accommodation can be removed at a pace that is likely to be measured," the Federal Open Market Committee said in a post-meeting statement.

While the key federal funds rate on overnight loans between banks remains at 1 percent, the Fed eliminated a reference to policy patience adopted in 2003, implying it may raise rates sooner rather than later to ward off potential inflation pressures.

The funds rate is the Fed's primary tool for influencing the economy. It is at a 45-year low after the Fed cut rates 13 times since early 2001 in an effort to foster a vigorous expansion.

The dollar eased while a rally in Treasury bonds lost some pre-meeting momentum.

The Fed last raised official interest rates in May 2000 to a relatively lofty 6.5 percent.

With the U.S. economic recovery gaining pace and breadth and companies reporting they are regaining the ability to make price hikes stick, policy-makers have been at increasing pains to imply they are on guard against potential inflation.

The Fed's objective is to keep prices, and wage demands, from rising so fast that they in turn push up credit costs, hurting demand and choking off growth.

The U.S. central bank's primary tool for doing so is the federal funds rate levied on overnight loans between banks, now at just 1 percent after 13 cuts since early 2001 — the last of them in June last year.

"We have to recognize that maintaining the current level of the funds rate for too long will eventually result in an unwelcome increase in inflationary pressures," Fed Vice Chairman Roger Ferguson (search) said in San Francisco a month ago.

Recent economic data have shown a significant pickup in the pace of activity. The nation's gross domestic product grew at the heartiest pace in 20 years during the nine months through March 31 — averaging a 5.5 percent annual rate per quarter.

Though Greenspan and others have noted a lag in job growth, March saw healthy growth of 308,000 new jobs in March and forecasts are that the government will report on Friday the creation of another 173,000 in April.

A report Tuesday from the Commerce Department (search) showed a surge in factory orders in March. Orders rose a stronger-than-expected 4.3 percent to a seasonally adjusted $360.7 billion, the best monthly gain in nearly two years.

But prices also are on the rise, with more companies reporting they are boosting charges for a wide range of products while some increases — like $2-a-gallon gasoline — are painfully obvious to consumers.

A year ago, the specter of deflation or a prolonged downward spiral in prices, was a policy concern, but Greenspan recently laid that worry to rest in an official declaration to Congress that rippled through global financial markets as a clear warning rates were to rise.

"Threats of deflation, which were a significant concern last year, by all indications, are no longer an issue for us," Greenspan told Congress two weeks ago.

Reuters and the Associated Press contributed to this report.