Fed Raises Rates Again; Markets Shake It Off

The Federal Reserve raised the short-term interest rates it controls by another quarter of a percentage point Tuesday, reiterating concerns that “inflationary imbalances” loom in the economy and strongly hinting that more rate increases would follow.

The decision to tighten credit again, made by the Fed’s Open Market Committee, brought the trend-setting federal funds rate to 6%, the highest in almost five years.

In a brief statement, the Fed repeated previous warnings that unless something is done to slow the economy, “increases in demand will continue to exceed the growth in potential supply,” ultimately leading to inflation.

Fed policymakers hope the latest rate hike will help reduce this demand by making it costlier for consumers and businesses to borrow money to spend.

Many experts also believe the Fed is trying to slow the ascent in the hot portions of the stock market. But, on Tuesday, key market indexes rallied broadly--in part, some analysts said, because investors expect the Fed to remain reluctant to take more than a gradualist approach to rate increases.

“This is one of the most delicate policy situations [Fed Chairman] Alan Greenspan has been in,” said David M. Jones, chief economist at the Aubrey G. Lanston & Co. bond firm in New York. “He’s not going to do anything too aggressive, because he doesn’t want to pop the stock market bubble. He needs to let a little of the air out of it. But how much is enough?”

Jones believes that two more quarter-point rate increases by August would do the trick. But he admitted he couldn’t be sure in this unprecedented economy.

Tuesday’s increase in the fed funds rate--the overnight loan rate among banks--was the Fed’s fifth in the last 10 months, each measuring 0.25 point. In response, lenders have raised rates on business loans, mortgages and other consumer loans, and investors have pushed corporate bond yields up.

But so far, there has been little evidence that higher rates are having the Fed’s desired effect of slowing the economy significantly. On the contrary, consumers seem as eager as ever to buy cars, furniture and clothing, even if they have to pay more interest to finance the purchases.

Sales of cars, minivans and sport-utility vehicles have grown at an eye-popping annual rate of 24% in the last three months, despite a 27% leap in gasoline prices.

Nor are the Fed’s higher rates having much effect on business overall. Companies’ inventories rose faster than forecasters projected in January, but not by enough to keep pace with burgeoning business sales. The growing gap between inventories and sales suggests businesses have been underestimating demand for their products--and will have to accelerate output to close the gap.

The Fed, signaling the likelihood of more rate hikes, said Tuesday it “believes the risks are weighted mainly toward conditions that may generate heightened inflation pressures in the foreseeable future.”

Paul L. Kasriel, chief economist at Northern Trust Co. in Chicago, said that for him, some of the clearest evidence the rate hikes are working shows up in money-supply growth--an indicator that has fallen out of favor with Fed-watchers in recent years, but that he said remained a highly accurate predictor of economic activity.

Kasriel said the growth rate of America’s checking, savings and money-market accounts--a pool of money known as M2--has been shrinking every quarter since late 1998, and particularly in the first half of last year.

“That’s some evidence that the Fed’s tightening is starting to work,” said Kasriel, who predicts two more 0.25-point rate hikes by August. That would raise the fed funds rate to 6.5%, the highest since 1991.

The Fed also raised its less significant “discount” rate Tuesday from 5.25% to 5.5%.

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The Fallout for Other Rates

Here’s a look at interest rates important to consumers, including where those rates are now, how much they’ve risen since the last quarter-point increase in the Fed’s key rate (on Feb. 2), and the outlook given Tuesday’s quarter-point Fed increase.

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Sources: IBC Financial Data; Times research