The Federal Reserve continued its slow-motion campaign against inflation Tuesday, hiking its benchmark short-term interest rate by another quarter-point and signaling it would not ease its effort to rein in rising prices even as it acknowledged that the economy was slowing.
As expected, the central bank raised the federal funds rate to 3 percent. It was the bank’s eighth hike since June, but it still leaves the rate near zero when matched up against the pace of inflation, 3.1 percent over the past year.
The increase in the funds rate – what banks charge each other on overnight loans – led major banks to raise their prime lending rates to 6 percent from 5.75 percent. The prime, a benchmark for many business and consumer loan rates, is the highest since September 2001.
Fixed mortgage rates, influenced by longer-term bond yields, have shown little sign of rising. The average 30-year fixed rate is 5.78 percent. While the Fed has tripled its federal funds rate since June, mortgage rates have dropped nearly a half-point since then, a divergence that Fed Chairman Alan Greenspan has termed a “conundrum.” Some analysts, however, suggest that low long-term bond yields reflect investors’ belief that a slowing economy is more of a threat than rising inflation.
In its statement accompanying Tuesday’s decision, the Fed retained its language that it would continue to hike rates at a “measured” pace, but also noted that “pressures on inflation” continued to rise. The Fed also noted the economic slowdown in the first quarter of this year, an indication to investors that future rate hikes would continue to be modest.
The market zigzagged following the news, finally rallying in the final minutes after the Fed disclosed it had left out from its statement a sentence that said: “Longer-term inflation expectations remain well contained.”
That helped quickly lift the Dow Jones industrial average from a loss of about 46 points to end the session up 5.25 points at 10,256.95.
Treasury bond yields fell on news of the revised statement.
As usual following a Fed announcement, analysts carefully scrutinized every sentence. Veteran Fed-watcher David Jones said this was the first time in his memory that the central bank had gone back and edited its statement. The addition of its reassurance on inflation, Jones said, shows that the Fed is concerned about the slowdown.
“The fact that they went through all this trouble to release it says to me that Greenspan does not want to put as much emphasis on inflation as some in the market would,” said Jones, chief executive of DMJ Advisors in Denver. “The new surprise to the Fed is the unexpected softness in the economy in the first quarter, and while the Fed hopes that will be reversed with a rebound later, that’s the one thing they’re unsure of.”
Others focused on the Fed dropping its past reassurance that high energy prices were not leaking into core inflation. They said the communiqué showed the top priority would be keeping inflation in check.
“It’s blindingly obvious that inflation is at the top of the agenda,” said Ian Shepherdson, chief economist for High Frequency Economics. “This is a signal that they’re going to keep going unless the sky falls in on the growth front.”
Interest-hike scorecard
Winners
Savers: There will be higher interest rates for savings accounts, certificates of deposit and other interest-bearing notes.
Shoppers: Rising rates can act as a hedge against inflation.
Lenders: Banks, mortgage lenders and finance companies will see increased profits.
Losers
Borrowers: Debt, from credit-card balances to adjustable-rate mortgages, will cost more.
Business: Tighter credit could hurt the ability to expand and finance operations.
Economy: Growth is likely to slow with curtailed spending.
STAFF WRITER TOM TROUT
