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Markets’ slide becomes surge

Rally follows Fed’ s pledge to keep rates low for 2 years

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By Megan Woolhouse
Globe Staff / August 10, 2011

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Stock markets plunged, then rallied yesterday after the Federal Reserve said it would keep interest rates at historically low levels for at least two years and possibly take further measures if economic conditions worsen.

It was another wild day of trading in the battered market. Shortly after the Fed issued the policy statement, the Dow Jones industrial average tumbled more than 200 points before it rebounded to add 429.92 points and close at 11,239.77, the best one-day gain since March 2009.

Stuart Hoffman, chief economist at PNC Financial Services Group in Pittsburgh, said the gyrations show how jittery investors feel after a week that has seen furious selling, fears of a European economic collapse, and a US credit downgrade.

“To the Fed, this is a strong sign that they are concerned about the economy and that they will do whatever it can to prevent a weak economy from becoming a recessionary one,’’ Hoffman said. “It’s like your doctor telling you you’re sick and he has medicine rather than there’s nothing he can do for you. This isn’t the most potent medicine, but it is helpful.’’

The rally provided some relief after weeks of sliding stocks and two days of huge losses. Last Thursday, the Dow fell more than 500 points, followed by a 600-plus point drop on Monday that evoked memories of the 2008 financial crisis, which drove the nation into the longest recession in post-World War II history.

In addition to concerns over a weakening US economy, financial markets around the world have been hit with panicked selling because of worries about the European debt crisis. Earlier this week, the European Central Bank appeared ready to buy Spanish and Italian government bonds as way to help those nations stave off default.

If these nations defaulted, it could cripple European banks that hold the debt, and spread through the international financial system, hurting US and other banks that do business with European institutions.

The debt crisis has put increasing pressure on stronger European economies, such as Germany. The main German stock index has lost 19 percent since late July.

In the United States, economic growth has slowed to a crawl. The economy grew at a rate of less than 1 percent in the first half of this year, far lower than predicted. The pace of hiring remains anemic, while the US government plans to slash spending to curb its massive debt, which puts a drag on the economy.

Many households simply feel poorer and have seen few benefits from the economic recovery that began more than two years ago. Home values remain depressed, while retirement accounts and other investments have fallen. Consumer spending, which accounts for more than two-thirds of US economic activity, has hardly increased.

The Fed yesterday downgraded its outlook for the economy, predicting a “somewhat slower pace of recovery over coming quarters’’ than it did in June, noting increasing risks to growth. In an unusual move, the Fed said it would hold its benchmark short-term interest rates near zero until at least mid-2013.

Historically, the Fed has rarely, if ever given an explicit time frame for its policies. Analysts said the move sends a signal to markets that the bank is watching developments carefully and is ready to act. The Fed has not ruled out taking additional measures, such as resuming its purchase of government bonds, to pump more stimulus into the economy.

Gregory Daco, principal US economist at IHS Global Insight, said stocks fell after the Fed statement because of a “strong negative reaction’’ from investors who thought the central bank would do more to boost the economy. He said there may have been an expectation that the bank would announce another round of Treasury bond purchases, a move aimed at keeping long-term rates low, and encouraging businesses and households to borrow and spend.

But some analysts question whether low rates will bring growth when confidence is so low and worried businesses and consumers remain reluctant to borrow.

“The Fed doesn’t hold a silver bullet; it’s not going to save the economy by itself,’’ Daco said.

He noted that many of the solutions lie with the lawmakers and policy makers in the federal government. For example, an extension of the payroll tax cut and emergency unemployment benefits that benefited many American households this year could boost spending and the economy.

Congress is out of session for the summer and is expected to return after Labor Day. But the drive to reduce federal debt makes policies that would add to the deficit unlikely.

Christian Weller, an economist and professor of public policy at University of Massachusetts Boston and a senior fellow at the Center for American Progress in Washington, said he thinks the US economy has enough momentum to keep it from falling into a second recession.

Weller said the US economy lacks the velocity to lower the nation’s persistently high 9.1 percent unemployment rate anytime soon. The Fed also predicted high unemployment in its statement yesterday, noting that its revised outlook called for the nation’s jobless rate to “decline only gradually.’’

That is dark news to the 14 million Americans who are currently looking for work.

“The Fed has a limited mandate,’’ Weller said. “And a limited tool kit.’’

Material from the Associated Press was used in this report. Megan Woolhouse can be reached at mwoolhouse@globe.com.