Washington – Federal Reserve officials, confident that Hurricanes Katrina and Rita have slowed the economy only temporarily, raised their benchmark short-term rate Tuesday and indicated they are likely to keep nudging it higher to keep inflation under control.
The Fed’s top policymaking committee, in a statement released after its meeting, noted that efforts to rebuild the Gulf Coast states devastated by the storms will spur economic growth in coming months. Meanwhile, the group again expressed concern that higher energy prices and other costs may add to inflation pressures.
“(The Fed was saying), ‘Our radar screen is flashing red, and we’re going to continue to boost rates until the inflation genie is back in the bottle,”‘ said Richard Yamarone, director of economic research at Argus Research Corp.
Fed officials unanimously agreed to lift their benchmark federal funds rate to 4 percent from 3.75 percent. It was the 12th consecutive quarter-percentage-point boost since June 2004, when the rate was at a four-decade low of 1 percent.
Fed Chairman Alan Greenspan and his colleagues on the committee indicated they view the rate as still low enough to stimulate economic activity. They said they would probably keep lifting it at a “measured” pace, which has come to mean a quarter- point increase at each scheduled committee meeting.
Stock prices fell as investors concluded that the Fed is not likely to stop raising the rate soon. Investors in futures contracts linked to the Fed funds rate reflect market expectations that the Fed will raise it to 4.5 percent by Jan. 31, Greenspan’s last day in office.
Some analysts predict the rate may go as high as 5.5 percent by July before the hikes stop, which assumes his successor will want to keep them going for several months. President Bush has nominated his top economic adviser, Ben Bernanke, to become Fed chairman next year. Bernanke’s confirmation is considered likely.
Bernanke may want to preside over a few rate hikes at the outset of his tenure both to make sure inflation stays contained and to dispel any doubts about his determination to do so, analysts said.
“Failure to continue the rate hikes might send undesired signals,” Yamarone said. “Wall Street might interpret inaction as a ‘dovish’ attitude toward inflation, which is not exactly the confidence-instilling measure that a new Fed chair would wish to send.”
The federal funds rate, the interest rate charged between banks on overnight loans, influences many other borrowing costs in the economy. Major banks are likely to follow today by raising the prime rate on business loans by a similar quarter percentage point to 7 percent from 6.75 percent.
Many consumer rates, such as on credit cards and home-equity loans, may rise as well. Banks and other financial institutions may increase the rates they pay on certificates of deposit and money-market funds.
Long-term rates, such as those on 30-year mortgages, are determined by financial markets in response to many factors. The average rate on a 30-year fixed-rate mortgage last week was 6.15 percent, up about half a percentage point from a year earlier.
The Fed has raised the federal funds rate by 3 percentage points in 16 months. The Fed last raised the rate by that much in 1994-95, when it rose from 3 percent to 6 percent in 12 months, triggering turmoil in the bond market that contributed to the Mexican peso crisis, the Orange County bankruptcy and the failure of investment bank Kidder Peabody & Co.
The recent increases, in contrast, have been well-anticipated in the markets and absorbed with no such distress.
