Fed Leaves Rates Alone, Warns of Risks

With more evidence of a U.S. economic recovery rolling in every day, the Federal Reserve ended a year-long campaign of interest rate cuts Wednesday, leaving borrowing costs steady but warning there was still a risk of weakness.

After 11 consecutive rate reductions last year, Fed Chairman Alan Greenspan and his colleagues opted to keep the federal funds rate -- the interest that banks charge each other on overnight loans -- at 1.75 percent, the lowest level in 40 years. The decision was announced after a two-day closed-door meeting.

The more symbolic discount rate was also unmoved at 1.25 percent.

"Signs that weakness in demand is abating and economic activity is beginning to firm have become more prevalent," the Fed said in a statement explaining its decision. "With the forces restraining the economy starting to diminish ... the outlook for economic recovery has become more promising."

Commercial banks' prime lending rate, the benchmark for millions of consumer and business loans, has been reduced in lockstep with the Fed moves and continues at 4.75 percent, a level last seen in November 1965.

The Fed began cutting rates on Jan. 3, 2001, and ordered its last rate reduction on Dec. 11, its final meeting of the year. Those rate reductions were designed to revive the economy, which was ailing even before it slid into recession in March.

Even though the Fed opted to hold rates steady, it left the door open to further rate reductions if necessary.

"The degree of any strength in business capital and household spending, however, is still uncertain," the Fed said.

Still, many economists, believing the economy is on the mend, are not forecasting additional rate reductions.

"The more they keep easing now, the more they're going to have to unwind later on, a year or two down the road," said economist Mark Zandi of Economy.com in West Chester, Pennsylvania. "I foresee the Fed now being on hold for several months."

There are already signs that the economy may be seeing better days ahead.

Defying predictions of another negative quarter, the economy managed to eke out a 0.2 percent rate of growth in the final three months of last year, with most of the strength coming from brisk spending by consumers and government, the Commerce Department reported Wednesday.

The small increase in the broadest measure of the economy, the gross domestic product, could mean that economists will date the end of the recession around the end of last year or the beginning of this year.

Many economists had predicted that the economy, which shrank at a rate of 1.3 percent in the third quarter, would decline again at a rate of around 1 percent in the fourth quarter.

Manufacturing, hardest hit by the slump, could be turning a corner, recent economic reports suggest. Orders to U.S. factories for big-ticket goods rose by 2 percent in December, the government said Tuesday. The Institute for Supply Management earlier this month reported stronger manufacturing activity in December, a sign that the sector was beginning to emerge from a 17-month slump.

And the psyche of consumers, the lifeblood of the economy, appears to be improving, too, after having been shaken by the terrorist attacks. The Conference Board reported Tuesday that consumer confidence rose for the second straight month in January, getting back above its pre-Sept. 11 level for the first time.

Once the Fed stops cutting interest rates, financial markets often begin immediately to worry about when rate increases might begin. Most economists believe that won't occur until the second half of this year, and then they are looking for perhaps two or three quarter-point increases.

With the nation's unemployment rate now at 5.8 percent and expected to rise in the coming months, economists said Fed policy-makers will be keeping a close eye on the behavior of consumers, whose spending accounts for two-thirds of all economic activity.

Reuters and the Associated Press contributed to this report.