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The Honolulu Advertiser
Posted on: Friday, June 30, 2006

New Fed rate highest in five years

By Nell Henderson
Washington Post

WASHINGTON — Federal Reserve policymakers again raised a key interest rate yesterday to the highest level in more than five years and signaled they may raise rates further to combat rising inflation.

Consumer price inflation "has been elevated in recent months," the Federal Open Market Committee, the central bank's top policymaking group, said in a statement after announcing its decision to lift its benchmark interest rate to 5.25 percent from 5 percent, the 17th consecutive quarter-percentage point increase since June 2004. Markets, which had anticipated the move, rallied on the news.

The FOMC noted that "economic growth is moderating from its quite strong pace earlier this year, partly reflecting the gradual cooling of the housing market" and the effects of rising interest rates and energy prices.

The economic slowdown "should help to limit inflation pressures over time," the committee said, adding that "some inflation risks remain."

The statement suggested the FOMC would raise the rate again at its next meeting in August if inflation pressures stay strong, or leave it unchanged if they are ebbing.

The Fed's "objective here is to tell the markets the Fed will keep its eye on inflation, but it's going to be flexible," said Ethan Harris, chief U.S. economist at Lehman Bros. Inc. The Fed "is not oblivious to the risks to growth."

"We expect them to hike in August, but it's not a done deal by any stretch," Harris said.

The benchmark federal funds rate, the rate charged on overnight loans between banks, influences many other borrowing costs throughout the economy. Major banks followed the Fed's action by raising their prime rate on business loans to 8.25 percent from 8 percent.

Interest rates charged on credit cards, home equity loans and mortgages are likely to rise as well, but savers should benefit as financial institutions pay higher rates on money-market funds and certificates of deposit.

Interest rates on long-term loans have been rising in recent months, though more slowly than short-term rates.

The average rate on a 30-year fixed-rate mortgage, for example, was 6.71 percent last week, not much higher than its 6.29 percent level in June 2004 just before the Fed started raising the federal funds rate.

The Fed uses its influence over interest rates to promote healthy economic growth while keeping inflation contained. Higher interest rates cause consumers and businesses to spend less, slowing economic growth and dampening inflation pressures; lower rates do the opposite.

Economic growth has slowed sharply in the second quarter of the year, according to many analysts' estimates. Fed policymakers have said they expect the economy to grow at closer to a 3 percent annual rate in the months ahead, which should help lower inflation.

LOCAL BANKS FOLLOW WITH RATE HIKE

Hawai'i's three largest financial institutions — First Hawaiian Bank, Bank of Hawaii and American Savings Bank — announced they were raising their prime lending rates in response to the Fed's rate hike. First Hawaiian Bank said its increase went into effect yesterday. Bank of Hawaii and American Savings Bank said their increases were effective today.