Fed Raises Its Key Discount Rate Half a Point--Highest in 3 Years

The Federal Reserve, ignoring critical comments by the Bush Administration concerning its inflation-fighting efforts, today boosted its key discount rate by half a point to the highest level in almost three years.

The central bank said it was lifting the rate it charges banks for short-term loans immediately to 7% from 6.5% “in light of inflationary pressures in the economy.”

The move, likely to trigger increases in interest rates charged consumers, followed Wednesday’s 0.6% jump in consumer prices in January, which Fed Chairman Alan Greenspan called “disturbing,” and a half-point increase in prime rates to 11.5% by two big commercial banks on Thursday.

Prime rate increases were also announced after the discount increase today by other major commercial banks, including Bank of America, Citicorp, Chemical Bank and Manufacturers Hanover.

The increase in the prime rate is more significant to businesses and consumers because of its direct effect on loan rates, such as adjustable-rate mortgages. The discount rate is relatively little-used, and the latest increase only partially catches it up with increases in other rates.

The discount increase sent U.S. stocks and bonds sharply lower while the dollar rose modestly. The Dow Jones industrial sank more than 30 points to 2,257 in late morning trading as the prospect of higher borrowing costs unnerved Wall Street.

Little Impact on Currency

But the central bank’s move had little impact on the currency markets, which appeared to have expected the hike. The dollar, which opened at 1.8255 West German marks and 126.15 Japanese yen in New York, moved only slightly higher to 1.8245 marks ands 126.30 yen in late morning trading.

Concerned that the thriving U.S. economy may trigger a resurgence of inflation, the Fed has been trying for nearly a year to slow economic growth by nudging interest rates higher.

Most of its credit-tightening has been accomplished by siphoning cash out of the banking system, which forces the interest rates that banks charge each other for short-term loans, known as the federal funds rate, to rise.

But the Fed had held the discount rate low while open-market rates have risen, economists say. The central bank this week nudged the Federal funds rate to around 9.5% by draining reserves from the banking system.

Slowing the Activity

By raising the cost of borrowing, the Fed hopes to slow the pace of business activity and curb inflationary pressure.

Although the discount rate affects only a small fraction of the cash in the banking system--far less than the federal funds rate--raising it is viewed as a strong symbolic gesture of the Fed’s determination to combat inflation.

On Wednesday the Labor Department said consumer prices in January soared 0.6%, their biggest jump in two years. The rise prompted Greenspan to reiterate in testimony to a congressional panel the central bank’s “determination to resist any pickup in inflation in 1989.”

The rise in the discount rate dealt a blow to President Bush’s hopes that a robust economy and falling interest rates would make it easier to reduce the federal budget deficit.

It is therefore likely to heighten tensions between the Administration and the Fed. Treasury Secretary Nicholas Brady had already made it clear that he was unhappy with Greenspan’s tough line on inflation.

The Fed last lifted the discount rate half a point last Aug. 9, to 6.5%. The rate had previously been unchanged since Sept. 4, 1987, when the central bank raised it to 6%.