Fed Raises Rates, Sends Mixed Signal
The Federal Reserve on Wednesday boosted its benchmark short-term interest rate to 5% and, after months of signaling predictable hikes, gave Wall and Main streets a new message:
We aren’t sure what we’re going to do next.
About the only signal that Fed watchers could take to the bank Wednesday was that the Open Market Committee -- meeting for the second time under new Fed Chairman Ben S. Bernanke -- intends to be nimble, guided by developing economic data.
On the one hand, inflation remains too big a concern to dismiss the possibility of another rate hike, the committee said after unanimously approving its 16th quarter-point rate hike in a row.
Yet the group, whose next meeting is June 29, also suggested that it could take a break from its credit-tightening campaign depending on what picture of the economy comes into focus between now and then.
Further rate hikes “may yet be needed,” the Fed said. But their timing and extent “will depend importantly on the evolution of the economic outlook as implied by incoming information.”
The most recent batch of indicators has been anything but clear, however. Job growth slowed unexpectedly in April, suggesting a possible economic downshift. But wages rose, muddying that outlook.
The Fed’s decision making also is becoming more complicated for other reasons.
Its program of raising short-term rates can cool the U.S. economy but has little influence over global inflationary forces -- particularly the sizzling growth of emerging economies in Brazil, Russia, India and China. That’s what’s driving up prices for oil, gold, copper, steel and other commodities.
The global economic boom also is boosting long-term interest rates, which are controlled by the markets and not the Fed. Higher long-term rates could push up mortgage rates and further weaken the nation’s housing market, a key driver of consumer spending and U.S. economic growth.
Recent declines in the value of the U.S. dollar also could spur more inflation, as a weaker greenback pushes up prices of imported goods such as oil. To stem the dollar’s decline, the Fed may have to hike rates further, analysts say.
“Another rate hike June 29 is uncertain but cannot be ruled out,” said Sherry Cooper, chief economist at BMO Nesbitt Burns Inc.
“Odds increase with stronger economic data and rising price pressure.”
The Fed said it expected growth to slow to a “more sustainable pace, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.”
Although that view is widely held, the data aren’t in yet to support it, economists said.
“Therein lies the dilemma,” said Bernard Baumohl, executive director of Economic Outlook Group. “The Federal Reserve doesn’t want to be viewed as being behind the curve in fighting inflation.”
At the same time, Baumohl said, the Fed also wants to avoid making the mistake of continuing to hike rates just as business begins to downshift to below-trend growth.
“So all Bernanke and the Fed governors can do now,” he said, “is to carefully monitor signs to see if demand pressures are indeed weakening.”
The Fed policymakers also noted that price increases in energy and other commodities had had only a modest effect on overall inflation, and that gains in worker productivity had helped keep rising labor costs from being inflationary.
Still, the Fed indicated that it was concerned that increases in “resource utilization” -- Fed-speak for lower unemployment and higher factory use -- “have the potential to add to inflation pressures” along with high energy and commodities prices.
In response to the Fed hike, banks raised their prime lending rates to 8%.
That will in turn boost rates on certain loans tied to the prime, such as variable-rate credit cards and some home equity loans.
Wall Street was mixed. The Dow Jones industrial average gained 2.88 points, while other indexes fell back.
Traders in the so-called federal funds futures market, who bet on Fed rate moves, raised their expectations Wednesday that the central bank would boost rates in June.
Like many Fed watchers, Ed Keon, chief investment strategist for Prudential Equity Group, second-guessed himself, telling investors in a note that he believed this cycle of rate hikes was over.
Then again, he went on, the Fed could resume hikes or cut back “depending on what happens to the core inflation numbers and the employment and housing market the rest of the year.”
