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Fed keeps policy unchanged, remains willing to provide additional accommodation

Today, the Fed announced the maintenance of the Fed funds rate in the target range of 0% to 0.25% “for an extended period” and maintained its policy of reinvesting principal payments from its securities holdings that it established in August. There were no new policies announced, which disappointed those looking for the announcement of QE II. The assessment of the economic outlook was once again lacklustre with the recovery forecasted to be modest in the near term and inflation subdued "for some time.” The Fed added that the current level of underlying inflation is running "somewhat below those the Committee judges most consistent, over the longer term, with its mandate." In time, the Fed expects that inflation will rise back to levels that are consistent with the mandate. While most of the Fed's assessment echoed its August statement, a notable mention was made of bank lending having recently contracted at a slower pace.
Fed President Hoenig maintained his stance that the inclusion of the extended period language was no longer warranted and would eventually lead to imbalances in the economy that will undermine growth. Hoenig judges that the economy is recovering at a moderate pace and reiterated that he doe not "believe that continuing to reinvest principal payments from its securities holding was required to support the Committee's policy objectives."
The lack of action in today's meeting suggests to us that the Fed expects extremely low interest rates, and maintenance of excessive liquidity will be enough to sustain the U.S. recovery. Although some market participants may have been disappointed by the lack of action, the Fed's committed to "provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate." This commitment means that, in the absence of a return to a faster growth path exerting further downward pressure on the unemployment rate or increasing doubts about a turnaround and eventual increase in inflation, another round of quantitative easing cannot be ruled out. The statement also keeps the door open to implementing other policy tools if they are deemed more appropriate at the time. We forecast that the U.S. economy will grow at a modest pace for the remainder of 2010 and that growth will accelerate in 2011. Against this backdrop, labour market conditions will slowly improve preventing a sustained softening in prices. To ensure that the recovery continues and inflation returns to levels that are consistent with their mandate, we expect the current range for the Fed funds target to be maintained until the third quarter of 2011.

Source: RBC Economics