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Federal Reserve update: January 2012

January 26, 2012

| MoneyRates.com Senior Financial Analyst, CFA

The Federal Reserve expects that economic weakness will continue into 2014, according to the projections released Wednesday from its latest meeting. In response, the Fed indicated it will keep interest rates low through that time, meaning that savers shouldn't expect a reprieve from low savings account rates anytime soon.

The federal funds rate

The Fed's announcement made it unlikely that the federal funds rate, which has stood at a target of 0-0.25 percent since the last recession, will see any changes in the near future.

In addition to announcing its intentions on low rates, the Fed also released detailed projections of key economic indicators and the likely Fed responses over the next three years. Here's what these projections say the economy has in store:

  • Economic growth. The Fed has revised its projection of 2012's real GDP growth rate downward since November, from a range of 2.5 to 2.9 percent to a range of 2.2 to 2.7 percent. While this is expected to improve incrementally over the next two years, what is really disturbing is the Fed's forecast for the long-term growth rate of just 2.3 to 2.6 percent.
  • Unemployment. The Fed's projected range of 8.2 to 8.5 percent means it doesn't expect the unemployment rate to get much better this year. Even by 2014, the Fed expects this rate to have improved only to between 6.7 and 7.6 percent.
  • Interest rates. The Fed projections indicate no movement in interest rates this year or next, and a split vote on the likelihood of increase in 2014.

While the Fed has cited greater transparency as the reason for releasing these newly-detailed projections, it may actually be a tactic to get more mileage out of monetary policy. With short-term rates already near zero, there's not much more the Fed can do to lower those rates, but by signalling that it expects rates to remain low over the next few years, the Fed may be hoping to coax longer-term rates (which are set on freely-traded markets) to lower levels.

Negative consequences

While in some respects the Fed may simply be the messenger, many experts are expressing concern over the possible negative consequences of the Fed's low-rate approach. Some examples:

  • Inflation. It already flared up a little last year, and it could easily escalate again.
  • Lost income. Retirees and pension plans will continue to be hurt by the lower income levels resulting from low interest rates.
  • Bank turmoil. Low interest rates may lock banks into years of low profitability, meaning lower savings account rates, higher fees, and fewer choices for consumers.
  • The bounce-back effect. The Fed indicates that it considers the long-term normal for the federal funds rate to be around 4 percent. The question is, once it has kept this rate at around 0.25 percent for a few years, when will the economy be strong enough to withstand the shock of rates bouncing all the way back to 4 percent?

Still, these concerns haven't deterred the Fed from pursuing their current policy with renewed commitment, as the latest meeting outcome indicates. And unfortunately, that renewed commitment means that it could be years until the rates on CDs, saving accounts and money market accounts improve significantly.

MoneyRates.com Interest Rate Forecast: 2012

March 13, 2012: 0-0.25 percent

April 24-25, 2012: 0-0.25 percent

June 19-20, 2012: 0-0.25 percent

July 31, 2012: 0-0.25 percent

September 12, 2012: 0-0.25 percent

October 23-24, 2012: 0-0.25 percent

December 11, 2012: 0-0.25 percent

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