The Federal Reserve on Wednesday raised its benchmark short-term interest rate by a quarter-point, saying improving economic and job market conditions justified the move.
The widely expected hike in the so-called federal funds rate -- to 2% from 1.75% -- was the central bank’s fourth quarter-point increase since June and put the rate at its highest level since the end of the last recession in 2001.
More hikes are coming, the Fed suggested, reiterating that it will continue to remove its easy-money policy at a “measured” pace to ward off inflation.
“Output appears to be growing at a moderate pace despite the rise in energy prices, and labor market conditions have improved,” the Fed’s policymaking Open Market Committee said in announcing the rate increase. “Inflation and longer-term inflation expectations remain well contained.”
That wording suggested that the Fed had become slightly more bullish on the economy since its last meeting, economists said. In announcing its previous rate increase on Sept. 21, the Fed said economic growth had regained “traction” and job conditions had improved “modestly.”
Investor reaction to Wednesday’s hike was muted. The Dow Jones industrial average fell 0.89 point to finish at 10,385.48 on Wednesday, although it and other indexes were higher before the Fed announcement. Treasury bond yields rose slightly.
Barring significant political or economic jolts, many analysts expect another quarter-point hike at the Fed’s next meeting Dec. 14. The central bank normally refrains from hiking rates in December, trying not to be a Scrooge during the holidays. But last week’s Labor Department report, showing surprisingly strong job growth of 337,000 net positions in October, forces the Fed’s hand, those analysts said.
The latest Fed action will immediately raise rates on short-term consumer loans, such as home equity, auto and credit card borrowings. They are generally pegged to banks’ so-called prime rate, which major institutions raised to 5% from 4.75% on Wednesday after the Fed’s move.
However, rising rates will benefit savers by lifting yields on certificates of deposit, money market funds and other instruments.
The eventual goal of the Fed and Chairman Alan Greenspan is to boost the short-term rate to a level considered to be “neutral” -- neither stimulating nor slowing the economy. Although the Fed has never said what that level is, economists put it at between 3% and 4%.
However, Greenspan should exercise care with further hikes amid continued threats to economic growth, some analysts said.
One of the biggest threats is oil prices. Although they have fallen from record levels, a resurgence in gasoline costs could bite into consumers’ pocketbooks. Oil price shocks may have knocked as much as half a percentage point off the third quarter’s growth rate of 3.7%, some economists estimated.
The Fed might want to pause from raising rates at its next meeting amid high oil prices, the Iraq war and other geopolitical uncertainties, said Sung Won Sohn, chief economist at Wells Fargo Banks.
Such risk factors show that the Fed “does not have as much control over the economy as it used to,” Sohn said.
Other risks include the ballooning federal budget deficit and continuing declines in the dollar.
Eventually, higher rates could hurt the housing market, particularly in regions such as Southern California where price surges have raised concerns about the possibility of a housing bubble.
Mortgage rates have risen recently amid signs of stronger economic growth, although they still are lower than their levels in June, when the latest round of Fed tightening began.
Bernard Baumohl, executive director of the Economic Outlook Group in Princeton, N.J., suggested that the Fed should retain its easy-money policy until the job market returns to a steady pace of creating at least 200,000 net new jobs every month -- enough to cover population increases.
The next jobs report, for November, will be released Dec. 3, more than a week before the next Fed meeting.
At its current level, the federal funds rate is basically zero when adjusted for inflation, Baumohl noted. Keeping it there would be “a tidy way to end the year,” he said.
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Excerpts From Fed’s Statement
The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 2%.
The Committee believes that, even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity.
Output appears to be growing at a moderate pace despite the rise in energy prices, and labor market conditions have improved. Inflation and longer-term inflation expectations remain well contained.
The committee perceives the upside and downside risks to the attainment of both sustainable growth and price stability for the next few quarters to be roughly equal. With underlying inflation expected to be relatively low, the committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.