Fed vows to peg rates until growth improves

The US Federal Reserve last night promised to hold interest rates at their lowest level for 45 years until the world's largest economy pulls out of its two-year stagnation.

Renewing its warnings that deflation poses a bigger threat than inflation to the US economy, America's central bank kept official borrowing costs at 1%, a level not seen since 1958.

Rates could stay low for "a considerable period", the Fed said in a statement following the decision. The Fed's open market committee has cut rates 13 times since early 2001 in the hope of kickstarting US growth and after recent signs of an American recovery, few analysts had expected further cuts at yesterday's meeting.

But the cautious tone convinced many that the Fed is alarmed about the sharp rise in longer-term borrowing costs and is determined to signal to bond markets that inflation is no threat. Yields rebounded sharply after the Fed appeared to play down the dangers of deflation at its June meeting, leading to accusations that policymakers had confused the markets.

"It looks as though the Fed does not want to spook the markets any more than they have been spooked," said Peter Cardillo, director of research at Global Partners Securities.

The Fed said that its main concern for the foreseeable future was the potential for inflation to move "undesirably low".

"In these circumstances, the committee believes that policy accommodation can be maintained for a considerable period," the statement said.

Stephen Stanley, senior market economist at RBS Greenwich Capital, said: "They tried to stick to the basics and did a pretty good job, hopefully minimising the chance the statement will be misinterpreted. The most important change is the sentence they added at the end, being very explicit that we can have accommodative policy for a long period of time, given the inflation situation. That should have been clear, but they've underlined it and put it in red letters."

America's brief recession officially ended in October 2001, but the recovery has failed to create jobs. US factories and businesses have shed upward of two million jobs since President Bush took office in 2001.

White House economists hope sweeping tax cuts stimulate a recovery in the second half of the year, rescuing the President from a repeat of the sour economic news which dogged his father's re-election campaign 12 years ago.