US Fed holds steady on benchmark rate

The US Federal Reserve kept its benchmark interest rate level yesterday, as had been widely anticipated by economists. The Fed's board of governors, which meets quarterly to consider changes in interest rates, left the rate at two per cent. Yesterday's decision marks the second time in a row the board has kept rates the same, following a string of cuts stretching back to Sept 2007. A decision in favour of the status quo was expected as the Fed and its chairman, Ben Bernanke, contemplate the best way to respond to a looming recession and rising inflation in the US. Recently-revised figures showed a decline in GDP of 0.2 per cent in the fourth quarter of 2007, fuelling concern that the country was on the brink of a recession. A recession is traditionally defined as two successive quarters of GDP shrinkage.

Inflation in the US, meanwhile, hit a 27-year high in June. Lowering interest rates could help stimulate economic activity but could stoke inflation. Raising rates could keep the lid on inflation but stifle an economic recovery. With these twin pressures in mind the Fed faces tricky decisions ahead. "The Fed is trying to walk a tightrope between an inflation situation that makes the board uncomfortable and the serious risk of a downturn", said Fabio Scacciavillani, an economist at the Dubai International Financial Centre.

The Fed's decision also has implications for the GCC, where all currencies aside from Kuwait's are pegged to the US dollar. When the Fed changes rates, central banks where there are dollar pegs must change their rates in concert, creating the possibility of a situation where American monetary policy is out of sync with the appropriate policy for the GCC. With inflation in all GCC countries but Bahrain in double digits, higher interest rates would be appropriate, economists say. And yet the Fed has either reduced rates or kept them level for nearly a year.

Most GCC countries have indicated they have no plans to de-peg currencies and formulate their own monetary policy ahead of a planned GCC currency union as early as 2012. @Email:afitch@thenational.ae