http://www.latimes.com/business/la-fi-fed4may04,1,4150511.story
Fed Raises Key Interest Rate to 3%
The central bank continues its effort to rein in inflation despite a slowing economy.
By Nicholas Riccardi
Times Staff Writer
May 4, 2005
The Federal Reserve continued
its slow-motion campaign against inflation Tuesday, hiking its key
short-term interest rate by another quarter point and signaling that 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 target rate to
3%. It was the Fed's eighth hike since June, but it still leaves the
rate near zero when matched against the ever-climbing pace of
inflation, which has risen to 3.1% over the last 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% from
5.75%. The prime, a benchmark for many business and consumer loan
rates, now is the highest since September 2001.
But mortgage
rates, influenced by longer-term bond yields, have been easing
recently. The average 30-year fixed home loan rate is 5.78%, according
to mortgage firm Freddie Mac.
While the Fed has tripled its
short-term rate since June, mortgage rates have dropped nearly 0.5
percentage point since then, a divergence that Fed Chairman Alan
Greenspan has termed a "conundrum."
Some analysts, however,
suggest that lower long-term bond yields reflect investors' belief that
a slowing economy is more likely than rising inflation.
In its
statement Tuesday, the Fed retained its language that it would continue
to hike 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, which some analysts said was an
indication that future rate hikes would continue to be modest.
Stocks zigzagged after the news, then rallied in the final minutes of
trading after the Fed announced that it had inadvertently left out from
its statement a sentence it had included in previous recent statements,
that "Longer-term inflation expectations remain well contained."
The Fed's late correction to its statement helped to quickly lift the
Dow Jones industrial average from a loss of about 44 points to end the
day up 5.25 points at 10,256.95. Bond yields fell on the news of the
revision.
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 revised its statement. The addition of its reassurance on
inflation, Jones said, showed that the Fed was 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. "The new surprise to the Fed is
the unexpected softness in the economy in the first quarter, and while
the Fed hopes that will be reversed with a rebound later, that's the
one thing they're unsure of."
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 was keeping inflation in check.
"It's blindingly obvious that inflation is at the top of the agenda,"
said Ian Shepherdson, chief economist at High Frequency Economics in
Valhalla, N.Y. "This is a signal that they're going to keep going
unless the sky falls in on the growth front."
Some economists
believe that could happen. First-quarter growth clocked in at an annual
rate of 3.1%, the government announced last week, well below
expectations although still in line with historical averages. Some
forecasters believe growth could slow even further as rising gasoline
prices continue to take a bite out of consumer spending, presenting the
Fed with a challenge: taming inflation while not damaging the economic
recovery.
When the Fed raises interest rates to quash
inflation, it increases many consumer and business borrowing costs,
thereby slowing economic growth.
"What does the central bank do
when their growth goal is compromised and their inflation goal is
compromised at the same time?" asked Allen Sinai, head of Decision
Economics in New York. "Hopefully, we're not stuck with that choice,
but increasingly it looks like we're going to sacrifice some growth in
the name of maintaining inflation in a low range."
Jones, of
DMJ Advisors, believes that if the economy continues to soften, the Fed
could halt its hikes later this year when its benchmark reaches 3.5% or
3.75%, in line with expectations of the bond futures market. The Fed is
expected to boost rates another quarter point at its next meeting June
28-29.
Others see the economy remaining strong and the Fed staying committed to a steady march of quarter-point rate hikes.
"They've got the economy right where they want it," said David Wyss,
chief economist at Standard & Poor's in New York. "They're happy to
see the economy slow down — they just don't want it to slow down too
much."
*
(BEGIN TEXT OF INFOBOX)
The Fed's Statement
Text of the Federal Reserve's statement Tuesday on interest rates:
The Federal Open Market Committee decided today to raise its target for
the federal funds rate by 25 basis points [0.25 percentage point] to 3%.
The committee believes that, even after this action, the stance of
monetary policy remains accommodative and, coupled with robust
underlying growth in productivity, is providing ongoing support to
economic activity. Recent data suggest that the solid pace of spending
growth has slowed somewhat, partly in response to the earlier increases
in energy prices. Labor market conditions, however, apparently continue
to improve gradually. Pressures on inflation have picked up in recent
months, and pricing power is more evident. Longer-term inflation
expectations remain well contained.
The committee perceives
that, with appropriate monetary policy action, the upside and downside
risks to the attainment of both sustainable growth and price stability
should be kept roughly equal. With underlying inflation expected to be
contained, the committee believes that policy accommodation can be
removed at a pace that is likely to be measured. Nonetheless, the
committee will respond to changes in economic prospects as needed to
fulfill its obligation to maintain price stability.
*
(BEGIN TEXT OF INFOBOX)
Outlook for other interest rates
Here's a look at where some key interest rates stand and the outlook in
the wake of the Federal Reserve's latest boost in its benchmark rate
from 2.75% to 3%.
*
Item: Prime lending rate
Current rate: 6%
Outlook: Major banks usually raise the prime lending rate in tandem
with Fed shifts, and many did so Tuesday, lifting their rate from 5.75%
to 6%. The prime is a benchmark for many consumer loans, such as home
equity credit lines.
*
Item: Money market fund average yield (seven-day)
Current rate: 2.25%
Outlook: Money fund yields typically track Fed rate changes, with a lag
of six to eight weeks before a rate change is fully reflected. The
average fund yield has risen 0.27 point since the Fed's last
quarter-point rate hike on March 22.
*
Item: Six-month CD yield (U.S. average)
Current rate: 2.21%
Outlook: Certificate-of-deposit rates have been rising at a steady pace
since last summer. They are expected to continue heading gradually
higher if the Fed keeps pushing its key rate up.
*
Item: 10-year Treasury note yield
Current rate: 4.17%
Outlook: Signs of a slowing economy have pushed long-term bond yields
lower since early April, despite expectations that the Fed would
continue to raise short-term rates. Long-term interest rates are set by
the marketplace rather than by the Fed, and are influenced primarily by
the economy's strength and by inflation trends. Lower bond yields
suggest that many investors expect a weaker economy and don't believe
inflation will get out of hand.
*
Item: 30-year mortgage rate (Freddie Mac average)
Current rate: 5.78%
Outlook: Mortgage rates generally follow bond yields. The average
30-year home loan rate has fallen from a recent peak of 6.04% the week
ended April 1 and is well below the 2004 peak of 6.34% reached last May.
*
Graphics reporting by Tom Petruno
*
Sources: Informa Research Services, ImoneyNet Inc., Freddie Mac, Bloomberg News
