Fed Boosts Rates for a Third Time : Economy: Newest quarter-point increase in interest in the last 90 days shakes financial markets. Concerns are raised about whether action may curb the recovery.
The Federal Reserve raised short-term interest rates Monday for the third time in less than three months, sending another shiver through financial markets already bloodied by mounting fears of inflation and rising borrowing costs.
The Fed’s move to raise to 3.75% the benchmark federal funds rate, which banks charge each other for overnight loans, came far more quickly than most analysts had expected. The quarter-point increase raised new concerns about whether the Fed is being so aggressive in its efforts to choke off inflation that it may actually curb the fledgling economic recovery.
The nation’s major banks responded by raising the prime lending rate by a half percentage point to 6.75%. That marked the second increase in less than a month, and it placed the prime rate at its highest level since 1991.
The Fed’s action is also certain to drive up interest rates on a wide variety of other business and consumer loans--although banks have so far been reluctant to increase the rates they pay out to depositors on certificates of deposit and savings accounts.
Now most Wall Street analysts and economic policy-makers within the Clinton Administration believe the Fed will continue to raise rates until it is convinced the economy can continue to grow without bringing on a surge in prices. Most analysts believe that the Fed will gradually increase the federal funds rate until it plateaus around 4.25% by the end of the year.
“All the economic indicators are still quite strong, and so I think the Fed will continue to move,” observed David Hale, chief economist at Kemper Financial Services in Chicago.
On Monday, stock and bond prices tumbled again after Fed Chairman Alan Greenspan announced the rate hike following a morning conference call with other Fed members. The Dow Jones industrial average fell 41.05 points to close at 3,620.42. The 30-year Treasury bond fell $14.38 per $1,000 in face value as its yield rose to 7.42% from 7.28% on Friday.
The Fed’s last two rate increases, on Feb. 4 and March 22, also sent stock and bond prices down as traders feared higher rates would harm the value of their investments.
Greenspan, who took the action without asking for a vote of the Fed’s key policy-making committee, was clearly responding to mounting evidence the economy is growing at a more rapid pace than economists predicted at the beginning of 1994.
Yet the action also came just days after the government issued reports suggesting inflation is still in check; Clinton Administration officials privately argue that there is no evidence to support the Fed’s growing concerns about rising prices.
President Clinton and his advisers on Monday continued their policy of refraining from criticizing the Fed’s actions. Robert E. Rubin, chairman of the National Economic Council at the White House, believes strongly that criticism from the Administration will only roil the financial markets and undermine the Fed’s credibility.
“I would hope that we continue not to comment, because the long-term health of the economy requires an independent Fed,” noted one senior Administration official.
Yet the Fed’s rate hikes have created an awkward situation for the Administration, which has consistently argued that a chief benefit of its 1993 economic plan would be lower interest rates.
So while they refuse to challenge the Fed’s decision to raise rates, Clinton and his aides make no secret that they believe the central bank is exaggerating the threat of inflation.
“There’s still no evidence of troubling inflation in this economy, but there is a lot of evidence of growth,” Clinton said Monday in Milwaukee. But to make it clear he was not trying to pick a fight with Greenspan, Clinton added that the latest increase still leaves interest rates “within the range that should not do harm to the economy.”
Clinton should soon have his own appointees on the Fed’s board of governors to give voice to his concerns on monetary policy. Administration officials said Monday that they hope to announce later this week the appointment of White House economist Alan Blinder to become Fed vice chairman, succeeding David Mullins, who resigned earlier this year.
In addition, White House sources say they now have a leading candidate to fill a second vacancy on the seven-member board and hope to make a final decision this week. Administration officials refused to reveal the name of the likely nominee, except to say the person is a woman economist who is not now working in the Clinton Administration. If named, she will succeed Wayne Angell, a Republican whose term expired in February and who was known as one of the chief anti-inflation hawks inside the Fed.
In an interview Monday, Blinder refused to comment directly on the rate increase but made it clear that he does not believe the Fed’s actions have begun to drag economic growth.
“What we’ve seen is that rates are going up while private economic forecasters are still raising their estimates of economic growth, not lowering them,” Blinder said. “So it looks like interest rate (increases) are being driven by economic growth, not the reverse. The economy is growing, and that is pushing rates up.”
Still, the Fed move clearly caught Wall Street off guard. Last week’s modest inflation figures had convinced many analysts that the Fed would not raise rates again for another month or so, especially considering how badly each earlier increase had shaken the financial markets. They were expecting that the next rate increase would not come until the May 17 meeting of the Federal Open Market Committee, which sets monetary policy for the central bank.
One Fed official who asked not to be identified said the Fed has been deeply concerned about the response on Wall Street to its rate hikes since February. The official noted that the Fed’s leadership has been especially surprised by the extent to which long-term interest rates have risen in response to the Fed’s increases in short-term rates.
He noted that the Fed moved Monday in spite of such worries but added that some senior Fed officials are increasingly concerned about whether they themselves are exaggerating the threat from inflation.
In addition, Greenspan’s decision to announce the rate increase publicly again may have fueled the swift response in the markets. Many analysts believe that Greenspan has decided to change longstanding Fed policy and publicly announce its actions immediately as a way to respond to congressional pressure for greater disclosure.
But Fed spokesman Joseph Coyne said Monday that the central bank has not decided on a permanent change in policy and is still studying whether to continue to announce each rate increase immediately.
Many consumer and business loans are tied directly to the prime rate. It is, for example, the benchmark used to calculate rates charged on such things as credit cards.
* BEARISH NEWS: Stocks fell and bond yields rose sharply after the Fed hike. D1
