Federal Reserve Chairman Alan Greenspan and his Board of Governors met on December 10th and figured rates were low enough. They decided to keep the Federal Funds Rate, which is the interest rate that banks charge each other for overnight funds, at 1.25 percent - the lowest level since 1961.

The decision to leave rates alone follows a larger than expected half percent cut at its last meeting on November 6th, and was no surprise to Wall Street. In fact, the statement issued by the Fed after the meeting was as wishy-washy as its decision to stay the course.

The Fed cited the current low rate "coupled with still robust underlying growth in productivity, is providing ongoing support to economic activity." That sounds to me like the Fed thinks we're well on our way towards economic recovery.

In the same statement, the Fed said that low rates were still necessary while the economy is "working its way through its current soft spot." That sounds to me that the Fed thinks we're certainly not out of the woods yet.

Which is it Mr. Greenspan? Are we in a recovery or not? My guess is that he doesn't know any more than the rest of us.

Experts seem to agree on one thing: The Fed is acting aggressively to sustain economic growth and prevent recession. Janet Yellin, a former Fed Governor predicted that the Fed would rather see "a recovery that is too strong rather than one that is too weak" and is likely to leave rates unchanged "for a good, long time."

So what's the future hold for mortgage rates? Unfortunately, the Fed's control over the overnight bank lending rate carries little influence in the movement of long term interest rates, such as 30 year fixed rate mortgages. Remember that the Federal Funds Rate is a very different financial instrument that a 30 year mortgage. Contrary to what many people think, a drop in the Federal Funds rate by the Fed does not equate to a similar drop in mortgage rates. In fact, the opposite can (and has) occurred.

Consider this: The Fed has lowered the Federal Funds rate by a total of 5.25 percentage points in the last two years. The aftermath of almost all incremental moves resulted in a temporary spike in mortgage rates.

Here's what happens: The market interprets a Fed rate cut as opening the door for inflation. If inflation picks up, the value of long term investment instruments such as bonds and mortgage-backed securities erodes. So investors sell these instruments, which ultimately causes mortgage rates to rise.

On the other hand, the market can interpret a Fed rate drop as a signal that there is no inflation threat, so investors will snap up bonds and mortgage securities, causing long term rates to drop.

The bottom line? It's a screwy and unpredictable market. However, evidence does suggest that interest rates - long and short term - are likely to stay down, not without fluctuation, as long as the Fed keeps its target rate low. And most experts agree that unless something major happens, it is likely to do so.

Unless something major happens? Well, that needs to be the subject of a different column.

Published: December 12, 2002

Use of this article without permission is a violation of federal copyright laws.

, the president of PMC Mortgage Corporation in Alexandria, VA, is a mortgage columnist whose work has appeared in numerous consumer, real estate, and mortgage publications. Mr. Savage welcomes your questions for possible use in this column, however because of the volume of mail received, Mr. Savage cannot answer questions individually.