Lending rates increase on Fed's interest rate hike

Advertiser Staff and News Services

WASHINGTON — The Federal Reserve, discounting recent signs of economic weakness, pushed ahead yesterday with its campaign to keep inflation under control by boosting a key interest rate by a quarter-point.

Wall Street, encouraged by the Fed's optimistic assessment of economic prospects, pushed stocks higher.

Declaring that the economy "appears poised to resume a stronger pace of expansion," Federal Reserve Chairman Alan Greenspan and his colleagues announced they were increasing the target for the federal funds rate from 1.25 percent to 1.50 percent.

Hawai'i's three largest banks and many Mainland banks immediately followed that move by announcing they were raising their prime rates, the benchmark for millions of business and consumer loans. Bank of Hawaii, American Savings Bank and First Hawaiian Bank each raised their prime lending rates from 4.25 to 4.5 percent.

The increase in interest rates could lead to higher home mortgage rates and a decline in demand in Hawai'i's sizzling home resale market. Last month, the median price for a single-family home on O'ahu fell slightly to $480,000, after hitting a record high of $481,000 the month before.

Many economists read the Fed's statement as a signal that the central bank intended to keep pushing rates up by quarter-point moves at each of its remaining three meetings this year.

"This is a very confident statement. They are unequivocal in their view that the economy is going to revive," said Mark Zandi, chief economist at Economy.com.

Investor confidence was bolstered by the Fed's assurances that the recent slowdown should be temporary, and stocks moved sharply higher. The Dow Jones industrial average finished the day up 130.01 points at 9,944.67.

President Bush, who is seeking to avoid his father's fate of being one-term president because of a weak economy, is insisting that the economy has turned the corner. A slump in various economic statistics in recent weeks have cast doubts about that contention.

The government reported last Friday that only 32,000 jobs were created in July, the poorest showing this year and far below the 200,000-plus jobs analysts had been expecting.

After that weak report, many analysts believed the Fed would go ahead with an expected quarter-point rate hike this week but might signal that it was prepared to pause in September if the economy had not shown signs of a rebound by then.

The Fed statement yesterday did note that economic growth had moderated and the improvement in the labor market "has slowed." But it blamed the slowdown on the spike in energy prices, and said it should be short-lived.

The boost in the funds rate marked the second quarter-point move this year, after a June 30 increase which had been the Fed's first rate increase in four years. Like its June statement, the Fed again said it believed it could raise rates "at a pace that is likely to be measured."

Economists have interpreted that as meaning quarter-point moves at regular intervals of Fed meetings. Many saw its repetition in the August announcement as a sign that the central bank sees no need to alter its plan for steady but modest rate increases in coming months.

Analysts noted that even with a half-point increase in the funds rate so far, this key Fed policy lever remains at a level that, before last year's cut, was last reached in the early 1960s.

"The Fed is not putting the brakes on the economy," said Bill Cheney, chief economist at MFC Global Investment Management in Boston. "They are just getting their foot off the accelerator."

Economist David Jones, author of several books on the Fed under Greenspan's leadership, said he still believed the Fed could put its credit tightening on hold, at least for September, if the August jobs report, due out Sept. 3, does not show sharp improvement.

"The fact that they acknowledged the softness in the economy injects a note of caution in the Fed's actions," Jones said. "I think they are going to be very measured and cautious going forward."

The central bank pushed the funds rate to a 46-year low of 1 percent in June 2003, the 13th in a series of rate cuts that began in January 2001 as the Fed battled to right the economy after a series of blows including the country's first recession in a decade, the Sept. 11 terrorist attacks and a wave of corporate accounting scandals.

In yesterday's statement, the Fed said it believed an economic revival was being supported by interest rates that were "accommodative" and by "robust underlying growth in productivity."

Earlier yesterday, the government reported that productivity in the April-June quarter rose at an annual rate of 2.9 percent. That was the smallest gain since late 2002, but it was still significantly higher than the anemic productivity increases posted during the 1970s and 1980s.

The Associated Press and Advertiser staff contributed to this report.