Posted at 12:13 p.m., Tuesday, November 1, 2005
Fed boosts key interest rate to 4 percent
By Nell Henderson
The Washington Post
The Fed's top policymaking committee, in a statement released after its meeting, noted that efforts to rebuild the Gulf 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, for a 12th consecutive hike 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, and said they would probably keep lifting it at a "measured" pace, which has come to mean a quarter-percentage point increase at each scheduled committee meeting.
Stock prices fell as investors concluded 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 S. 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 in financial markets 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 to the global financial markets."
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 savers' certificates of deposit and money market funds.
Long-term rates, such as those charged on 30-year mortgages, are determined by financial markets in response to many factors. Home loan rates have been rising recently. The average rate on a 30-year fixed-rate mortgage last week was 6.15 percent, up only about a half-percentage point from a year earlier, according to mortgage finance company Freddie Mac.
With today's action, the Fed has raised the fed funds rate by 3 percentage points in 16 months. The Fed last raised the rate by that much in 1994-1995, when it rose from 3 percent to 6 percent in 12 months. During that episode, the central bank acted more aggressively than the markets expected, 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.
Indeed, the economy has been growing smartly even with rising interest rates and energy prices. The nation's gross domestic product, the value of all goods and services produced, grew at a 3.8 percent annual rate in the July-September period, a pickup in momentum after expanding at a 3.3 percent pace the previous quarter.
Many analysts worried that the economy might slump after the hurricanes sent energy prices spiking, wiped out thousands of jobs and disrupted shipping systems. Fed officials also worried that high energy prices had caused consumers to expect higher prices for other items, which might fan inflation.
Since then, energy prices have retreated from their post-Katrina highs. Crude oil was trading today at around $59 a barrel, down from nearly $70 a barrel right after the storm, on the New York Mercantile Exchange.
The national average price today for a gallon of regular gas is $2.48, down from a high of $3.06 a gallon on Labor Day, according to the AAA auto club.
More than 500,000 workers filed new claims for unemployment insurance benefits because of the storm, but job growth outside the hurricane-affected region remained robust in September, the Labor Department reported.