Posted on: Wednesday, May 4, 2005
Fed bumps up interest rates with inflation in mind
| • | Bank deposit rates could also see boost |
By Nicholas Riccardi
Los Angeles Times
The Federal Reserve yesterday continued its slow-motion campaign against inflation, raising 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 ever-climbing pace of inflation, which has risen to 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, now is the highest since September 2001.
Mortgage rates, influenced by longer-term bond yields, have showed little sign of rising. The average 30-year fixed mortgage rate is 5.78 percent. While the Fed has tripled its federal funds rate since June, mortgage rates have dropped nearly 0.5 percentage points 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 yesterday's decision, the Fed retained its language that it would continue to raise rates at a "measured" pace, but also noted that "pressures on inflation" continued to rise. The Fed also acknowledged 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 after 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 44 points to end the session up 5.25 points at 10,256.95.
Treasury bond yields fell on the news of the revised statement.
As usual after 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.
Others focused on the central bank dropping its previously issued reassurance that high energy prices were not leaking into core inflation. They said the new communique showed the Fed's 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."
