Fed Raises Key Rates, Warns of Future Increases
The Federal Reserve raised key short-term rates one-quarter of a percentage point Wednesday to ward off inflationary pressures in a roaring U.S. economy, and coupled the action with warnings that suggest more hikes are on the way.
The Fed’s policy-making Open Market Committee nudged up the federal funds rate, which banks charge each other for short-term loans, from 5.5% to 5.75%, its highest level in more than four years. It was the fourth such increase since last June, when the central bank began its efforts to slow the economy.
In the wake of the Fed decision, Bank of America, the nation’s biggest bank, and other major financial institutions announced they would raise their prime lending rates, assuring that millions of consumers and businesses will feel the effects of higher interest.
But will the pinch be great enough to convince them to throttle back their spending so the economy can cool? On this, analysts seemed to agree: “It won’t do a great deal,” said Sung Won Sohn, chief economist of Wells Fargo & Co. in Minneapolis.
Fed policymakers appeared to acknowledge as much in a statement accompanying their rate decision.
Despite raising rates by a full percentage in the past eight months, the policymaking committee said it “remains concerned that, over time, increases in demand will continue to exceed the growth in supply.” It warned that “such trends could foster inflationary imbalances that would undermine the economy’s record economic expansion.”
“They’re saying they will take whatever steps are necessary to keep inflation from accelerating,” said Mickey D. Levy, Bank of America’s chief economist.
Analysts said the Fed’s strategy is to continue raising rates in modest increments until the economy finally slows. “It’s going to be Chinese water torture,” said Merrill Lynch & Co.’s chief economist, Bruce Steinberg.
The strategy has decidedly not worked thus far. Since the Fed first signaled its readiness to slow growth last May, rates on 10-year industrial bonds, a bellwether of corporate borrowing costs, have climbed a full percentage point, and so have those on conventional 30-year mortgages.
During that period, the economy still managed to grow more than 4%. But most economists believe that sooner or later the rate increases will take their toll.
The stock market reacted to the Fed’s action by swinging up and down before ending the day little changed. Analysts said investors were still unsure about how seriously the Fed takes the inflation threat and how hard it will clamp down on growth.
The Dow Jones industrial average fell about 38 points, or 0.3%, and the broader Standard & Poor’s 500 index slipped a tiny 0.16 point. Only the technology-heavy Nasdaq composite index rose, up about 22 points, or 0.5%.
The price of 30-year Treasury bonds jumped dramatically, pushing their yield, which moves in the opposite direction, down to 6.29% from 6.43% on Tuesday.
Normally, that would mean investors believe inflation is under control and are willing to accept lower rates.
But analysts dismissed the signal as the product of an unrelated Treasury Department announcement Wednesday that it is shrinking the number of bonds it issues because the government is running a surplus.
In addition to boosting the federal funds rate, the Fed raised the largely symbolic discount rate, which the Fed itself charges private banks, from 5% to 5.25%. The response by commercial banks included increasing their prime lending rate from 8.5% to 8.75%.
The case that growth needs to be slowed has been bolstered in recent days as the nation entered its record-breaking 107th month of expansion, and the government announced that the economy had grown at a feverish 5.8% annual rate during the last three months of 1999.
A report Friday showed that the employment cost index, a broad measure of employers’ costs for worker wages and benefits, had jumped an unexpectedly high 1.1% in those same three months.
Two more reports Tuesday concluded that booms in construction and manufacturing were pushing up raw materials costs. Rising wage and supply costs signal a danger that prices generally will follow suit, setting off an inflationary spiral.
Some analysts had predicted that the new reports would persuade the Fed to hike rates more sharply than it did.
But the central bank was restrained by a conviction that efficiency improvements are helping companies offset higher costs on their own, and by worries that a steeper rate hike might send the stock market into a dive.
“They’re trying to maintain a very delicate balance,” said David M. Jones, chief economist of Aubrey G. Lanston & Co. and a veteran Fed watcher. “They want to cool off red-hot demand growth without cooling off the stock market too much.”
* FED STATEMENT
Text of Fed’s statement. C4
* MARKET REACTION
Markets ended mixed on Wednesday after the Fed moved. C1
