Fed Pushes Up 2 Key Interest Rates, Signals End to Increases : Economy: Half-point hike is double the size of boosts agency made earlier this year in effort to stave off inflation. White House is relieved and Wall Street reacts with buying spree.
The Federal Reserve, in its most aggressive inflation-fighting action of the year, raised short-term interest rates Tuesday by half a percentage point, then signaled its intent to hold off on additional hikes.
In an unusual public statement suggesting the future direction of interest rates, the Fed indicated that Tuesday’s large rate hike--double the size of its moves earlier in the year--might be the last it imposes for the foreseeable future.
Fed officials moved to raise two benchmark interest rates underlying the rates charged by banks and other lenders for short-term loans. The federal funds rate was boosted to 4.25% from 3.75%, and the Fed’s discount rate was increased to 3.5% from 3%--the first discount rate increase in five years.
“These actions . . . substantially remove the degree of monetary accommodation which prevailed throughout 1993,” the Fed said in a statement issued at the end of a closed-door meeting of the Federal Open Market Committee, a policy-setting panel composed of Fed governing board members and regional bank presidents.
The unusual statement, which indicates that the Fed does not see an immediate need for further rate hikes, was greeted with relief at the White House and celebrated with a buying frenzy on Wall Street. Administration officials were anxious that the Fed’s efforts to squelch future inflation might spoil the economic recovery, and bond and stock traders feared that a continuing series of rate hikes would cause the markets to sink.
“That was an A-plus statement,” one senior Administration official said. “It takes a weight off of our shoulders.”
Although the Administration has steadfastly refused to criticize the Federal Reserve since the central bank began boosting rates in February, senior aides said President Clinton had become increasingly concerned in recent weeks about rising interest rates. Tuesday’s statement should ease those concerns, Administration officials suggested.
Before the Fed’s announcement, Clinton sought to dismiss worries that the Fed’s actions might dampen the economic recovery.
“I have every confidence that we’re still going to have another good year this year and that we will be able to offset any modest increase in interest rates with increased growth,” Clinton told reporters.
Tuesday’s increase in the discount rate, the rate the Federal Reserve charges banks for short-term borrowings, was the first since Feb. 24, 1989. The federal funds rate, an overnight lending rate that banks charge each other, stood at 3% before the Fed raised it for the first time in five years on Feb. 4. The initial quarter-point increase was followed by identical moves in March and April.
One White House source said the Fed’s recent rate hikes have created sharp divisions within the Administration. Labor Secretary Robert B. Reich, in particular, has been highly critical of the central bank’s anti-inflation crusade because of its potential dampening effect on the recovery.
The midafternoon announcement sparked a dramatic rally in the closing hours of the nation’s financial markets. In the bond market, where many investors had expected the Fed to continue ratcheting short-term rates up for the next few months, long-term interest rates began to fall. The decline suggests that the market had exaggerated its fears about inflation and the prospect that short-term rates were headed ever higher.
“I think we got a statement that tells the markets that the Fed is done, at least for the summer,” said Alan Levenson, an economist at UBS Securities in New York.
“The hopeful thing about what happened Tuesday is the lowering of long-term rates as a result of the Fed’s statement,” said Thomas Thompson, president of the National Assn. of Home Builders. The trade group has been an outspoken critic of the Fed’s interest rate increases because of their impact on mortgage rates and home sales.
While long-term interest rates eased, short-term rates rose in tandem with the Fed hike. Major commercial banks, led by Citicorp, moved immediately to take advantage of the Fed’s action by increasing their prime lending rates half a percentage point to 7.25%.
The latest rate increase, the fourth by the Fed since February, came in the face of growing opposition within Congress and criticism by outside analysts who questioned the need for a tough anti-inflation campaign at a time when there is little evidence of rising prices.
On Monday, for instance, California’s two Democratic senators, Barbara Boxer and Dianne Feinstein, sent a letter to Federal Reserve Chairman Alan Greenspan, complaining about the impact of interest rate increases on the California economy.
House Banking, Finance and Urban Affairs Committee Chairman Henry B. Gonzalez (D-Tex.), the Fed’s fiercest critic in Congress, chided the Fed and the nation’s banks for their actions Tuesday.
“The Fed couldn’t resist an irrational impulse to raise interest rates and the banks couldn’t wait to use the excuse to instantly raise their prime rates, though their spread is the fattest ever,” said Gonzalez, referring to the difference between the rates that banks charge borrowers and pay to depositors. Gonzalez is sponsoring legislation to reduce the Fed’s independence by increasing oversight by the President and Congress.
Critics who argue that the Fed is putting its foot on the brakes before the economic recovery gathers real momentum can point to plenty of recent evidence that inflation is not a threat. Economic growth seems to be moderating after an initial spurt last winter, and the latest government reports show few signs of surging prices. Last week, the government reported that consumer prices rose just 0.1% in April.
But Greenspan and other officials of the central bank argue that they have been raising rates not because inflation is visible today, but to keep inflation at bay in the months and years ahead.
* FINANCIAL IMPACT: How higher rates will affect business and consumers. D1
Economic Adjustments
In raising two key interest rates, the Federal Reserve is sending a strong message that it aims to check any inflationary spiral.
THE FEDERAL FUNDS RATE
The rate banks charge each other for short-term loans 1992 April 9: 3.75% July 2: 3.25% Sept. 4: 3.00% 1994 Feb. 4: 3.25% March 22: 3.50% April 18: 3.75% Tuesday: 4.25% *
DISCOUNT RATE
The rate at which the Fed lends money to commercial banks. 1991 Feb. 1: 6.0% Nov. 6: 4.5% Dec. 20: 3.5% 1992 July 2: 3.0% 1994 Tuesday: 3.5% *
THE AIM: To head off inflation without damaging economic growth
THE FEAR: Economic activity will suffer, especially in California
THE IMPACT
* Stocks and bonds posted impressive gains.
* Major U.S. banks hiked prime lending rates by 0.5 percentage point to 7.25%.
* Borrowing costs are expected to rise on short-term consumer and business loans; rates on mortgages and other long-term loans could fall if inflation fears ebb.
