Fed Says Rates Likely to Stay Low Until Mid-2013, Global Financial Strains Pose Risk

The Federal Reserve on Tuesday left its fiscal policy unchanged in the wake of what it described as a modestly expanding economy. The European debt crisis, high unemployment in the U.S. and a stagnant domestic housing market remain concerns, however.

Interest rates will likely stay at their historically low levels through mid-2013, the Fed announced, maintaining a policy adopted earlier this year.

“Information received since the Federal Open Market Committee met in November suggests that the economy has been expanding moderately, notwithstanding some apparent slowing in global growth,” the Fed said in a statement.

Stock markets dropped immediately following the release of the statement at 2:15 p.m., with the Dow Jones Industrial average quickly falling into negative territory from a session high 126.31.

In explaining its decision to maintain existing policies, the Fed statement offered contrasting economic data.

The U.S. economy has been expanding “moderately,” the Fed said, but global growth is apparently slowing. Overall labor conditions have improved, but the unemployment rate is still “elevated.” Consumer spending is rising, but business investment isn’t rising fast enough and the housing market remains “depressed.”

The selloff likely resulted from language included in the statement in which Fed policy makers made it clear economic recovery is still a long way off.

“The Committee continues to expect a moderate pace of economic growth over coming quarters and consequently anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate” of full employment and stable prices, the statement read.

In addition, the long-running European debt crisis remains a potent threat to the U.S. “Strains in global financial markets continue to pose significant downside risks to the economic outlook,” according to the statement.

Meanwhile, the Fed chose not to change its communications policy, as some analysts had predicted. Fed policy makers in recent months have floated the idea of tying policy changes to real numbers. For instance, moving interest rates only when unemployment or inflation numbers reach a specific level.

The idea is to provide businesses and investors with clarification as to why the Fed has decided to change its fiscal policy. In the past, Fed decisions were almost always kept secret until the change was announced, leaving businesses and investors scrambling to adjust to the new policy.

Analysts generally approve of such a move and the Fed – in particular, Fed Chairman Ben Bernanke – has indicated its desire to be less secretive involving policies that affect the U.S. and global economies.

“We believe the precise formulation of any new guidance is less important than the simple act of committing to some criteria for future action,” analysts with Nomura Securities wrote in a note to clients.

The Fed said it held off on any new stimulus measures in the wake of economic recent reports that show some positive economic growth. Topping that list, the unemployment rate fell to 8.6% in November from 9.0%, which is psychologically important but likely due to the fact that many thousands of Americans have simply stopped looking for jobs.

Meanwhile, interest also remained unchanged at their historic lows. A key borrowing rate set by the Fed has been at a range between 0 and 0.25% since December of 2008.

And the Fed gave no hint as to the likelihood of future bond buying programs to stimulate the economy. The Fed has pumped $2.3 trillion into the flagging U.S. economy through bond buying programs since the darkest days of the financial crisis.

Instead of new policies, the Fed said it will continue its program to extend the average maturity of its holdings of securities, a program announced in September. Also maintained was an existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.