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STOCK investors usually welcome low interest rates, but not this time. If anything, the US Federal Open Market Committee's latest policy statement has reinforced concerns over the unsteady pace of the global economic recovery. The Federal Reserve reiterated after its meeting on Wednesday that it would keep interest rates near zero for 'an extended period' and specified for the first time that policy will stay unchanged as long as inflation expectations are stable and unemployment fails to decline. 'Businesses are still cutting back on fixed investment and staffing, though at a slower pace,' the Fed statement said. 'Household spending appears to be expanding, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth and tight credit.'
In itself, the Fed's decision to leave interest rates unchanged was not unexpected. While official data showed last week that the US economy grew for the first time in a year in the third quarter, ending the worst recession in decades, the 3.5 per cent expansion in GDP is expected to slow in the fourth quarter as government support measures wind down and unemployment continues to rise. With nearly 10 per cent of the labour force out of work, consumer spending (the main driver of the US economy and key to a sustainable recovery) remains weak. But notable still is the signal that interest rates would remain very low, probably well into the next year at least, and the Fed's reading that the economic recovery would not be sustainable without policy support.
The Fed spelt out explicitly the economic conditions that would warrant leaving rates at low levels for an extended period: low rates of resource utilisation, subdued inflation trends, and stable inflation expectations - conditions that are likely to persist for some time.
'If, as we fear, economic growth begins to slow again next year, as the boost from pent-up demand and restocking fizzles out, then interest rates could stay at near-zero until 2012 or even beyond,' said Capital Economics in one analysis.
Stocks in the US fell after the Fed statement, and Asian stocks also lost ground yesterday. The prospects of a long period of very low interest rates heaped more misery on the US dollar, which slid as much as 1.2 per cent after the Fed meeting. The Fed's stance also suggests that commodity prices would continue their rise as the US dollar weakens further. Gold reached a record high on Wednesday after the Fed's decision prompted a sell-off of the US dollar as investors looked elsewhere for higher-yielding assets. The Fed also left the issue of record oil prices unaddressed.
And there may be more danger ahead. A falling US dollar and surging commodity prices could combine to pose an inflation threat down the road. If this happens when economic growth is still fundamentally weak, it would severely restrict the Fed's ability to manoeuvre in setting interest rates. The relatively simple task of keeping interest rates very low may well give way to more complexities in monetary policy decisions in 2010.
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