Fed to keep interest rates at zero amid debate over future leadership

Federal Reserve noted difficulties in economy and decided to continue its two major forms of stimulus at July monthly meeting

The Federal Reserve sounded a somber note about the US economy on Wednesday and left its stimulus program unchanged at its monthly meeting, amid an increasingly high-pitched battle over who should lead the institution next year.

The Federal Reserve Open Market Committee, or FOMC, decided at its July meeting on Wednesday to continue its two major forms of stimulus: keeping the $85bn bond-buying program known as quantitative easing and to keep interest rates at zero.

The members of the committee, which includes Federal Reserve chairman Ben Bernanke, indicated they are maintaining their policy because the US economy had only slightly improved in the past month.

"Information received since ... June suggests that economic activity expanded at a modest pace during the first half of the year," the FOMC said in a statement. It pointed to improved conditions in the labor market, higher household spending and business investment and a stronger housing sector.

The Fed statement also noted several difficulties in the economy. The unemployment rate "remains elevated," members said, while mortgage rates are rising and a deadlocked Congress holding up budget policy is "restraining economic growth."

The committee's wary tone on the economy is in marked contrast to its more chipper pronouncements just last month, when chairman Ben Bernanke said "generally speaking, financial conditions are improving" and "the fundamentals look a little better to us," crediting the housing sector in particular for creating construction jobs and supporting consumer spending.

This month's Fed focused on only "modest" growth raised some eyebrows among economists. Paul Edelstein, US economist for IHS Global Insight, said the statement indicates that the "committee views the pace of activity as 'modest' instead of 'moderate' – a definite downgrade."

Edelstein said the Fed implied the economy needed to improve, in contrast to recent optimistic statements from the Fed about its growth. "Instead of expecting economic growth to 'proceed at a moderate pace,' the Fed now expects that 'economic growth will pick up from its recent pace'" he wrote.

The US gross domestic product, or sum of all the goods and services sold in the country, was estimated to land at 1.7%, an anemic number well below the ideal of 2.5% to 3% that many economists say will signal a strong recovery. The Fed has forecast GDP growth of up to 2.6% for 2013, which it predicts will rise as high as 3.6% in 2015.

Joseph Brusuelas, an economist with Bloomberg LP, said the Fed's caution signalled bad news, with the statement "indicating that the committee remains apprehensive on making substantive changes given the persistent under-performance of the economy and the problems in the labor market."

Brusuelas concluded that the "Fed remains split into several camps uncertain about how to proceed given the sluggish economic conditions" as well as little support from Congress.

A similiarly skeptical note about the pace of economic recovery was sounded by William Dunkelberg, the chief economist for the National Foundation of Independent Business, who questioned why GDP growth looks more robust than the depressed employment market. About 12 million are unemployed in the US.

"These GDP growth numbers do not square with the growth in employment averaging over 190,000 per month," Dunkelberg said. "What are these new employees making? The growth in part-time jobs may explain part of this 'inconsistency.' But overall, the job market isn't looking any better."

Meanwhile, an increasingly bitter battle over the succession of Fed leadership dominated the day.

Bernanke's term ends in January, and Barack Obama said he would appoint a successor no later than September. The identity of that successor, however, has divided Congress and economists alike. Many are rooting for Janet Yellen, the veteran Fed vice chair, while the president is said to favor former treasury secretary Larry Summers.

The president heatedly defended Summers against critics on Wednesday, "reacting emotionally" and deriding news outlets including the Huffington Post for making Summers "a progressive whipping boy." He asked vocal Senate Democrats to give Summers "a fair shake" according to a report in the Financial Times. The president also threw another name into the mix: former Fed vice chair Don Kohn.

Obama said people "would have to slice the salami very thin" to find the differences between the three candidates.

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