Analysts look to past to predict rate increases
By Vivien Lou Chen
Bloomberg News
The Federal Reserve's decision to lift its target lending rate for the first time since May 2000 may just be the beginning. The U.S. central bank has raised the benchmark an average of eight times in the first year of each tightening cycle of Chairman Alan Greenspan's 17-year tenure.
Policy makers boosted the so-called federal funds rate an average of 2.67 percentage points in six to 12 steps during three rate-increase phases since 1987, each lasting 11-12 months. The smallest total advance was 1.75 percentage points, the largest 3.25 points, according to Bloomberg data.
The Fed lifted borrowing costs yesterday to 1.25 percent from a four-decade low of 1 percent in a bid to stem inflation. The economy is in its 11th quarter of expansion, 1.2 million jobs have been added since January and the Commerce Department's price index for May matched the largest one-month gain in almost 14 years.
"The magnitude of rate increases in the first year could well seem large," given the extent of rate cuts that began last year, said Anthony Crescenzi, chief bond market strategist for Miller Tabak & Co. in New York.
The Fed is forecast to raise the target interest rate for overnight loans between banks to at least 4 percent, though it may take until the end of 2005 or longer to reach that level, according to economists at the largest bond-trading firms surveyed by Bloomberg News last month.
"There might be some clues in past cycles," said Richard Berner, chief U.S. economist for Morgan Stanley in New York. Still, "mostly we look to the rate constellation that the Fed is aiming for," he said.
The largest rate increases under Greenspan took place over an 11-month period between March 1988 and February 1989, when the federal funds rate was raised in 12 steps to 9.75 percent from 6.5 percent, according to Bloomberg data. The target stayed at that level until June 1989.
The next biggest rate advance was from February 1994 to February 1995, when the target was raised in seven steps to 6 percent from 3 percent.
"Greenspan saved the day by his bulldog determination," said former Fed governor Wayne Angell. "The rate of inflation didn't accelerate in 1994, 1995 and 1996, and the Fed really succeeded by closing the inflation-risk door."
Technological advances make it possible this time to keep a lid on inflation by increases in the output of goods, the former Fed governor said.
That, along with the addition of workers from countries such as China and India, has helped to contain prices.
"The Fed knows that until you get wage-rate acceleration, price increases are not sustainable," Angell, 74, said. "It's not really a pre-inflation time."
The most recent period of rate increases began in June 1999 and ended in May 2000. The federal funds target was raised 1.75 percentage points in six steps to 6.5 percent during the 11-month period.
This time, the Fed may move more slowly, economists said.
"The Fed can take a gradualist approach to raising the funds rate" because inflation is low, said Louis Crandall, chief economist at Wrightson Icap LLC in Jersey City, New Jersey. He predicts the federal funds rate will ultimately rise by 3 percentage points or more.
"The process will take at least 18 months and possibly two years or more," Crandall said.
Greenspan cautioned against trying to predict the length and breadth of rate increases based on history in a May letter to U.S. Sen. Paul Sarbanes, D-Maryland.
Low interest rates "must be returned to a more neutral setting at some point," Greenspan told Sarbanes, the ranking Democrat on the Senate Banking Committee.
"Judging the likely pace and duration of that transition solely on the basis of past episodes is not appropriate."
