Fed Increases Key Rate to Aid Dollar : Anti-Inflationary Move to 6% From 5.5% Spurs Immediate Rise in Prime
The Federal Reserve Board, in its first major move since new Chairman Alan S. Greenspan took over from Paul A. Volcker last month, Friday raised a key lending rate to financial institutions to 6% from 5.5% in a bid to stabilize the falling U.S. dollar and calm inflationary fears.
The increase in the Fed’s discount rate, the first in more than three years, triggered an immediate wave of interest-rate hikes at major banks across the country and is likely to encourage the recent trend toward higher rates for a variety of loans, including home mortgages.
Led by New York’s Chase Manhattan Bank and Chemical Bank, which reacted only minutes after the Fed announcement, banks increased their prime lending rate to 8.75% from 8.25%.
“The decision reflects the intent of the Federal Reserve to deal effectively and in a timely way with potential inflationary pressures,” the central bank said in a brief statement.
Under Growing Pressure
Despite the sudden move by the Fed, which has been under growing pressure from financial markets to bolster the dollar by boosting short-term interest rates, further action may be necessary to produce a decisive effect on the U.S. currency.
“The markets may take this as little more than a token gesture,” said Ira Kaminow, chief economist of the private Government Research Corp. in Washington. “Anything less would have looked like the Fed was throwing in the towel against inflation.”
In currency trading Friday, the battered dollar was little changed. In New York, it closed at 141.95 yen, up from 140.97 Thursday. Against the West German currency, it was at 1.7970 marks, compared to 1.7910.
“You can see that at the moment practically nothing can help the dollar,” Alfred Zapfel, chief foreign exchange dealer at the Bank of Boston in Frankfurt, told Reuters news service.
Greenspan, following the eight-year span in which Volcker established a tough anti-inflation stance, is being closely watched by financial market participants for any signs that he might relax the Fed’s efforts to defend the dollar’s value.
“I think clearly he’s the new man on the block and the new kid on the block has to prove himself,” said David Wyss, a senior economist at Data Resources in Lexington, Mass. “I think he had to prove he was serious about keeping the dollar strong.”
“A modest tightening of monetary policy makes sense under current conditions,” said Charles Schultze, a senior analyst at the Brookings Institution in Washington and the chief economic adviser to former President Jimmy Carter. “The real question is whether it will actually be enough to satisfy the markets that Greenspan is just as determined to hold the line as Volcker was.”
The discount rate is the interest the central bank charges on loans to U.S. financial institutions. Ultimately, the higher U.S. interest rates that result from a hike in the discount rate should make it more attractive for traders to hold dollars and help stabilize the value of the currency, which has been slipping steadily since the Commerce Department reported last month that the trade deficit hit a record $15.7 billion in June.
The Fed, by moving to curb the falling dollar, is also aiming at damping inflationary fears because a weaker currency tends to make imported goods more expensive and lessens the pressure on domestic producers to hold down prices.
Construction Industry
But higher rates make it more expensive for business and consumers to borrow money and are likely to further weaken the faltering construction industry.
“Mortgage rates already have been drifting upward for fixed-rate mortgages,” said Mark Obrinksy, chief economist for the U.S. League of Savings Institutions. “Now we’re going to see them going upward for adjustable-rate mortgages as well.”
The Reagan Administration, which engineered an international agreement in February aimed at stabilizing the dollar after a two-year decline, endorsed the Fed’s move.
“The Administration concurs with the action of the Federal Reserve in raising the discount rate in order to maintain steady economic growth with low inflation,” said White House spokesman Marlin Fitzwater with vacationing President Reagan in Santa Barbara.
Cut Seven Times
The last increase in the discount rate was in April, 1984, when the Fed boosted it to 9% from 8.5%. Since then, the rate had been cut seven successive times, with the last reduction occurring on Aug. 20, 1986.
The vote in favor of increasing the discount rate was 4 to 0, with two Fed members, Robert Heller and Martha Seeger, absent.
Perhaps the most unusual aspect of the Fed move was its timing. It occurred early in the morning, suggesting that the central bank wanted to influence investors in financial markets before they break for the long Labor Day holiday weekend. Usually the Fed waits until the end of the business day to avoid jolting the markets.
Meeting in Europe
Greenspan is scheduled to be in Europe this weekend for his first meeting with other central bankers at the Bank of International Settlements in Switzerland.
“This is clearly Greenspan’s opening shot in his campaign to prove to the world that he is concerned about the dollar,” said Donald Ratajczak, chief economic forecaster at Georgia State University in Atlanta.
And with the latest figures on the U.S. trade imbalance due to be released on Friday, economists said that if July’s trade deficit is as high as in June, it could trigger another round of dollar-selling.
To counter that, the Fed may be forced to raise the discount rate again. “Greenspan may need fresh ammunition after the trade report,” Ratajczak said, “so he could be keeping some of his powder dry just in case.”
