Fed increases key interest rate

Published: Friday, July 1, 2005 at 6:01 a.m.
Last Modified: Thursday, June 30, 2005 at 10:44 p.m.
WASHINGTON - The Federal Reserve raised a key interest rate Thursday and signaled that Americans' borrowing costs probably will keep heading higher.
Still, the economy is on firm footing despite gyrating energy prices, Fed policy-makers said.
Chairman Alan Greenspan and his colleagues boosted the federal funds rate by one-quarter percentage point to 3.25 percent, marking the ninth increase of that size since the central bank began to tighten credit in June 2004 in an effort to keep inflation under control.
In response, commercial banks began lifting their prime lending rates, which are used for many short-term consumer loans, by a corresponding amount to 6.25 percent. The increases left both the prime rate and the funds rate at the highest levels since August 2001.
Wall Street, disappointed at the prospect of continued rate hikes, fell after the Federal Reserve announcement.
The Fed repeated a pledge it has been making for the past year to move rates up "at a pace that is likely to be measured." To analysts that phrase translates into additional quarter-point increases at the Fed's next meeting, Aug. 9, and through much of this year.
"The Fed is signaling it is full steam ahead for interest rate hikes," said Richard Yamarone, economist at Argus Research Corp. "The Fed would rather keep raising rates than end its campaign too soon."
Some analysts, concerned that rising oil prices might weigh on economic activity, had wondered whether there might be a break in the rate-raising campaign in August or perhaps later this summer. The Fed, however, gave no indication of that.
"Although energy prices have risen further, the expansion remains firm and labor market conditions continue to improve gradually," the policy-makers said in a statement issued after their two-day meeting ended Thursday.
Oil prices set a closing high of $60.54 a barrel on Monday but have retreated somewhat since.
Even after its string of increases, the Federal Reserve indicated that rates still remain relatively low. In Fed parlance, that was stated as: "The stance of monetary policy remains accommodative."
Stuart Hoffman, chief economist at PNC Financial Services Group, pointed to that phrase as another signal that rates were headed higher.
"The Fed is on autopilot," Hoffman said. "I think the Fed gave a pretty crystal clear indication that they will keep on raising rates."
From an economic point of view, high energy prices - for now - don't seem to be posing a threat to the economy that would change the monetary strategy, Hoffman said.
At its previous meeting, May 3, Fed policymakers had said consumer and business spending had slowed somewhat, partly because of rising energy prices. They didn't make this observation in Thursday's statement. Instead, they said economic conditions remain firm despite the high energy prices.
The economy grew at a solid rate of 3.8 percent in the first three months of this year. The unemployment rate dipped to a low 5.1 percent in May, though payroll growth slowed.
On the inflation front, the Federal Reserve said price pressures have "stayed elevated" but repeated the belief that longer-term inflation expectations "remain well contained." Policymakers didn't mention, as they had in previous statements, that "pricing power is more evident," meaning it was easier for companies to raise prices.
While consumer prices rose sharply in March and April, they actually fell in May.
Some economists believed the Fed's comments Thursday on inflation and the economy were a bit more upbeat compared with the May meeting.
Before the Fed embarked on its rate-raising campaign, the prime rate stood at 4 percent, the lowest level since 1958; the federal funds rate, the interest banks charge each other on overnight loans, was at 1 percent, a 46-year low.
Extraordinarily low rates had once been needed to rescue the economy from the 2001 recession, the terror attacks and a wave of corporate scandals that had rocked Wall Street. But the Fed over the past year has been gradually reining in the easy credit, an approach aimed at preventing inflation from becoming a problem while keeping the economy growing.
Some economists believe the funds rate could climb to as high as 4.25 percent by the end of this year. That would push the prime rate to 7.25 percent.
Despite the Fed's rate increases thus far, long-term interest rates, including those for mortgages, have fallen, a phenomenon that Greenspan has said is puzzling. Rates on 30-year mortgages this week sank to 5.53 percent, the lowest level in more than a year.

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