Fed’s Rate Hike Program Doesn’t Pause for Katrina
The Federal Reserve on Tuesday chose inflation-fighting over public relations, raising its benchmark short-term interest rate by another quarter-point, to 3.75%, against suggestions that it pause in deference to Hurricane Katrina.
The central bank’s policymaking committee also signaled that further rate hikes were in store, adding that although Katrina and accompanying energy price volatility “have increased uncertainty about near-term economic performance ... they do not pose a more persistent threat.”
Thus, with little long-term economic damage expected from Katrina, the committee reiterated its mantra that it could continue to boost rates at a “measured” pace -- Fed-speak for more quarter-point increases.
The decision wasn’t unanimous. Fed Gov. Mark W. Olson, a former Minnesota banker, voted against the rate hike, preferring that the central bank stand pat. It was the first formal dissent among Fed policymakers since they began their current rate-hiking program in June 2004.
The Fed’s 11th consecutive quarter-point rise in its federal funds rate to a four-year high was one of the most widely debated central bank decisions in recent years, given the sudden and broad economic shocks from Katrina. Some analysts had suggested that the Fed should pause in a show of compassion for Katrina victims and a recognition of the economic uncertainty created by the storm.
Instead, “the Fed has not been deflected from its prior course by Hurricane Katrina,” said Ian Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, N.Y.
Many banks immediately raised their prime lending rates by a quarter-point to 6.75%. That will in turn raise rates on a variety of consumer and business loans, including variable-rate credit cards and home equity loans. However, savings rates also will probably rise.
Stock market investors, who had hoped that the central bank might signal a relaxation in its rate-hiking agenda, were disappointed by Tuesday’s news. After trading in positive territory before the Fed announcement, major stock indexes closed lower. Bond yields were mixed.
The Fed rate hike didn’t damp a debate among analysts about whether higher inflation is a serious threat, and whether the economy is strong enough to regain momentum after Katrina.
Some analysts said that Fed Chairman Alan Greenspan and his colleagues should have paused, arguing that the economy is in danger of a slowdown amid surging energy costs, a decelerating housing boom and rising interest rates. Katrina may have wiped out some 400,000 jobs. Consumer confidence plunged after the hurricane, raising the specter of a pullback in consumer spending.
“All the facts aren’t in” on Katrina’s effect, said James D. Hamilton, an economics professor at UC San Diego. Given that uncertainty, “it makes a lot of sense to wait a couple months and see what it’s all going to bring.”
Other analysts, however, note that inflation threats are mounting. A new storm, Hurricane Rita, threatens energy production facilities in the Gulf Coast, heightening prospects for more price hikes in gasoline and natural gas.
Various transportation companies, including airlines and truckers, are trying to pass along higher fuel costs. Contractors warn of rising costs for home building materials.
The national unemployment rate of 4.9%, a four-year low, suggests a tightening labor market and rising wage pressures, some analysts say. A recent jump in gold prices to 17-year highs also is a sign of accelerating inflation, they say.
Those who support tighter credit believe it’s more important to cap inflation than to cut the economy more slack.
Still, Fed officials acknowledged that Katrina would take a toll in the short run.
“The widespread devastation in the gulf region, the associated dislocation of economic activity and the boost to energy prices imply that spending, production and employment will be set back in the near term,” the Fed said in its statement accompanying Tuesday’s rate boost.
But Fed policymakers also said the economy had enough underlying strength before Katrina. “Output appeared poised to continue growing at a good pace before the tragic toll of Hurricane Katrina,” the Fed statement said.
Also, although “higher energy and other costs have the potential to add to inflation pressures,” inflation without energy and food prices “has been relatively low in recent months and longer-term inflation expectations remain contained,” policymakers said.
The Fed statement prompted many analysts to reaffirm forecasts that the central bank would raise its key rate again to 4% at its next meeting Nov. 1.
However, there is some doubt about how much further the Fed might go beyond that, with some analysts suggesting the central bank will need to know more about the post-Katrina economic landscape before making any more moves.
The Fed’s goal is to boost its benchmark rate to a “neutral” level that neither stimulates nor depresses economic activity. But Greenspan and other central bank officials have not said what that rate is.
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Outlook for other interest rates
Here is a look at where some key interest rates stand and the outlook in the wake of the Federal Reserve’s latest boost in its benchmark rate from 3.5% to 3.75%.
Prime lending rate
Current rate: 6.75%
Outlook: A number of major banks raised the prime a quarter point Tuesday, matching the Federal Reserve’s rate increase. The prime, a benchmark for many consumer loans --such as home equity credit lines --usually changes immediately with Fed shifts. Next Fed meeting: Nov. 1.
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Money market fund average yield (seven-day)
Current rate: 2.96%
Outlook: Money fund yields are poised to top the 3% level for the first time in four years. The funds’ yields usually track Fed rate changes, with a lag of six to eight weeks. The average money fund yield is up 0.23 point since the Fed’s last quarter-point hike on Aug. 9.
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One-year CD yield (U.S. average)
Current rate: 3.09%
Outlook: Banks have been slower to raise certificate of deposit rates in recent weeks, compared with their pace earlier in the year. CD rates should continue to edge higher with the Fed’s latest rate hike.
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10-year Treasury note yield
Current rate: 4.24%
Outlook: Bond rates are set by the marketplace, not by the Fed, and take their cue from the economy’s strength and the outlook for inflation. The 10-year T-note yield is down from 4.39% when the Fed last met because some investors are betting on a slower economy.
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30-year mortgage rate (Freddie Mac average)
Current rate: 5.74%
Outlook: Mortgage rates typically follow long-term bond yields. The average 30-year home loan rate has dipped from 5.82% when the Fed last met.
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Graphics reporting by Tom Petruno; Sources: Informa Research Services, ImoneyNet, Bloomberg News
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Federal Reserve’s Statement
Here is the Federal Reserve’s statement Tuesday on interest rates:
The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points [0.25 percentage point] to 3.75%.
Output appeared poised to continue growing at a good pace before the tragic toll of Hurricane Katrina. The widespread devastation in the gulf region, the associated dislocation of economic activity and the boost to energy prices imply that spending, production and employment will be set back in the near term.
In addition to elevating premiums for some energy products, the disruption to the production and refining infrastructure may add to energy price volatility.
While these unfortunate developments have increased uncertainty about near-term economic performance, it is the committee’s view that they do not pose a more persistent threat. Rather, monetary policy accommodation, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. Higher energy and other costs have the potential to add to inflation pressures. However, core inflation has been relatively low in recent months and longer-term inflation expectations remain contained.
The committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, 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.
