Fed Targets Inflation, Hikes Rate Half-Point
Escalating its campaign to preempt inflation, the Federal Reserve on Tuesday raised a benchmark interest rate by one-half of a percentage point and hinted that there may be more credit tightening ahead.
It was the biggest Fed rate hike in five years and underlined the central bank’s determination to squelch what it called “inflationary imbalances that would undermine the economy’s outstanding performance.”
The unanimous decision by the policymaking Federal Open Market Committee brought the influential federal funds rate--the rate banks charge one another for book-balancing overnight loans--to 6.5%, highest since January 1991. The Fed also raised the less important discount rate by half a point to 6%.
Major banks reacted immediately by boosting their prime lending rates for business borrowers by a half-point, and economists said the increases would soon hit consumers as well.
The Fed’s series of rate hikes since last summer has lifted the prime rate to 9.5% from 7.75% a year ago. That has pushed rates on home-equity loans, many of which are tied to the prime, into double digits. Likewise, the average rate for 30-year fixed-rate mortgages is already at a five-year high of 8.5%, versus 7.1% a year ago.
At the same time, the higher rates mean better returns for investors in money market funds and other savings vehicles.
The latest rate hike came the same day that the Labor Department reported tame inflation for April, and critics quickly assailed the Fed’s move as unjustified and excessive. They said it hurts consumers and small businesses and could smother the record economic expansion.
Tuesday’s move alone will cost the average U.S. household $484 a year in additional interest charges, bringing the total annual cost of the Fed’s rate hikes since last June to $1,694, according to Sen. Byron L. Dorgan (D-N.D.).
“The Fed is flying blind on interest-rate policy,” Dorgan said in a statement. “Inflation is down, productivity is up. There is no excuse for central bankers to impose another increase in interest costs on the American people.”
Martin Regalia, chief economist for the U.S. Chamber of Commerce, chided the Fed for impatience.
“It often takes over a year before interest-rate changes affect the economy, and the Fed began to tighten less than 12 months ago,” he said. “At this point, to escalate from quarter-point increases seems premature, but it seems they got the OK from Wall Street and the next thing you know--bingo!--they go a half-point.”
Many analysts believe the Fed’s rate hikes, and the threat of more to come, were one factor contributing to many stocks’ sharp declines over the last two months. The Nasdaq composite index has dropped 26% since March 10. The blue-chip Standard & Poor’s 500 index is off 4% from its March peak.
In a four-paragraph statement accompanying its rate-hike announcement, the FOMC said it believes that “the risks are weighted mainly toward conditions that may generate heightened inflation pressures in the foreseeable future.”
The hawkish language in the statement, released at 2:15 p.m. Eastern time, caused the stock market to dive briefly. But by the end of the trading session, market indexes recovered to close broadly higher. The Dow industrials added 126.79 points, or 1.2%, to 10,934.57.
Wall Street was encouraged by the government report earlier Tuesday showing that consumer inflation advanced only weakly in April, following a disturbing leap upward the month before.
The new data convinced some economists that the March spike in the consumer price index was an anomaly and that inflation remains tame. “There’s very little real inflation,” said Carl Weinberg, chief economist at High Frequency Economics in Valhalla, N.Y. “The Fed’s goal is to keep inflation risks from getting traction.”
Clearly, the Fed thinks the risks are high. Despite five straight quarter-point rate hikes since June 30, the economy has stubbornly resisted Fed efforts to restrain it. Just Monday, the government reported that factory production remained strong, growing 0.9% in April.
Even though consumer inflation indexes remain relatively subdued, there are signs more companies are putting through price increases. The National Federation of Independent Business reported in a survey Monday that 25% of its small-business members reported higher selling prices in April.
Key commodity prices also have been on the rise this year, from energy to pork to wheat to cotton. The Commodity Research Bureau/Bridge index of 17 major commodities last week hit a two-year high.
Although the Fed did not state it explicitly, Richard Rippe, economist for Prudential Securities, believes its deepest concerns are over the tight labor market, and the potential for a surge in wage inflation. The U.S. unemployment rate just hit a 30-year low of 3.9%, with worker shortages reported in all parts of the country.
Unless the economy shows signs that businesses and consumers are borrowing and spending less by the Fed’s next meeting, June 27 and 28, the central bank may decide to raise rates still again, perhaps by another half-point, Rippe said.
“To come with another 50 basis-point hike--a full percentage point in two months--would be pretty strong medicine, but they might feel they have to do it,” he said.
Another factor on the Fed’s mind may be the presidential election. To avoid accusations of political motivation, analysts said, Fed governors would like to get their tightening done before the campaign heats up in the fall, ideally before their Aug. 22 meeting. That could imply a bigger rate-hike in June, these experts said.
There is a danger, as implied by the criticisms from Dorgan and Regalia, that the Fed will squeeze too hard and tip the economy into a recession. Some signs of economic slowing are already starting to show up in the housing market, said Daniel E. Laufenberg, chief economist for American Express Financial Advisors in Minneapolis.
Although a report Tuesday indicated that housing starts ticked up slightly from March to April, the April figure was down substantially from the average for the first three months of the year, Laufenberg said, adding that rising mortgage rates are almost certain to slow the sector further in the months ahead.
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Costlier Credit
The Federal Reserve’s interest rate increase pushed banks to raise their prime lending rate to 9.5% on Tuesday, highest since 1991. Many home equity loans and credit cards are tied to the prime--and so will cost more immediately.
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Tuesday: 9.5%
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Source: Associated Press
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Fed’s Effect on Rates
The Federal Reserve has raised the key federal funds rate by 1.75 percentage points over the last 12 months, but the effect on other loan, bond and savings rates has varied. A sampling of key rates a year ago and as of Tuesday.
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May 17, Change Item 1999 Tuesday (in points) Federal funds rate 4.75% 6.50% +1.75 Bank prime lending rate 7.75 9.50 +1.75 30-year mortgage 7.10 8.52 +1.42 1-yr. CD yield 4.62 5.64 +1.02 Credit card 15.70 16.57 +0.87 10-year Treasury note 5.60 6.42 +0.82
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CD yield is a national average on bank certificates of deposit; credit card rate is average for variable-rate cards nationwide.
Source: Imoneynet.com, Times research
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* MORE FED COVERAGE: C1, C4
