Fed Lifts Key Rate to 4.5% as Greenspan Signs Off
The Federal Reserve ended the Alan Greenspan era Tuesday by raising its benchmark short-term interest rate another quarter point and giving incoming Fed chief Ben S. Bernanke some flexibility to wage his own anti-inflation battle.
The central bank, as expected, raised its short-term rate to a nearly five-year high of 4.5% -- the 14th consecutive hike since June 2004 -- and said further rate increases “may be needed.” In its previous statement in December, the Fed said further rate hikes were “likely.”
The central bank also dropped the word “measured” in describing its expected future rate increases. Omission of that word -- which had become Fed-speak for continual quarter-point increases -- makes future rate decisions less predictable and more dependent on economic data at the time, analysts said.
“This gives Bernanke some wiggle room to put his own stamp on future policy moves,” said Scott Anderson, senior economist at Wells Fargo & Co. in Minneapolis. But for investors, such uncertainty “could increase volatility,” he said.
Although core inflation, which excludes energy and food costs, “has stayed relatively low in recent months,” inflation pressures could rise because of “possible increases in resource utilization as well as elevated energy prices,” the Fed said.
The central bank is concerned that low unemployment and tight business capacity could boost wages and prices, analysts said. Amid heightened Middle East tensions, oil prices have risen while costs for various commodities and industrial materials, from copper to sugar to aluminum, also have climbed higher. A report Tuesday showed accelerating wage increases in many sectors.
However, the Fed also reiterated confidence in the economic recovery, adding that “although recent economic data have been uneven, the expansion in economic activity appears solid.”
Many analysts and investors are betting that Bernanke -- a former Fed governor who easily won Senate confirmation Tuesday and will be sworn in as the 14th Fed chief today -- will raise rates by another quarter point at his first policymaking meeting March 28.
After that, many experts expect the Fed to call time out to assess the economic landscape.
Bernanke has said he would maintain “continuity” with Greenspan policies -- meaning he wouldn’t hesitate to hike rates if necessary to stem inflation. But the degree of Bernanke’s anti-inflation hawkishness and his approaches to economic crises are largely uncertain.
The 52-year-old Bernanke, most recently chairman of President Bush’s Council of Economic Advisors, has given relatively few clues about his views on today’s economy or interest rates.
Investors have driven up stock prices lately in hopes that the Fed is close to finished with its rate increases. They are hoping for a replay of 1994-95, when a Fed tightening cycle did not lead to a recession and instead laid the groundwork for five more years of solid growth and a surging stock market.
Further rate hikes, some analysts argue, risk slowing a recovery that -- at more than 4 years old -- is getting long in the tooth by historical standards. Higher rates also could further dent a housing boom that already is slowing.
“Because of the unprecedented vulnerability of overpriced residential real estate to higher interest rates, the Fed will probably hike interest rates more cautiously than in the past,” said John Lonski, an economist at Moody’s Investors Service Inc. in New York.
The government reported Friday that the economy grew at a surprisingly weak 1.1% annual rate in the final three months of last year, although many analysts expect that figure to be revised upward.
Growth in the current January-March quarter is expected to rebound to as much as a 4% annual rate. The economy grew 3.5% all of last year.
The latest evidence of a rebounding economy came Tuesday with the news that consumer confidence in January rose to its best levels in more than three years amid optimism about an improving job market.
But the Fed may be concerned about a slowdown in growth of worker productivity, a main force in subduing inflation. That could “be bad news for corporate profits and bad news for inflation,” said economist Anderson.
The government will release its initial estimate of productivity growth in the fourth quarter on Thursday. Economists expect it to plunge to an annual rate of 1% from a healthy 4.7% in the third quarter.
Another report Tuesday on employment costs showed that private sector wages and salaries accelerated in every sector except manufacturing and transportation, said Ian Shepherdson, chief U.S. economist for High Frequency Economics in Valhalla, N.Y.
Although that’s good news for workers, it could raise red flags with Bernanke, who has said that inflation responds to tightening labor and business conditions, Shepherdson said.
“The risk for wages is all on the upside for the foreseeable future,” Shepherdson said.
Tuesday’s hike in the Fed’s benchmark federal funds rate, which banks charge each other for overnight loans, put the rate at its highest level since May 2001.
That will lead to higher borrowing costs for consumers and businesses. Many banks on Tuesday raised their prime lending rates a quarter point to 7.5%.
Tuesday’s meeting ended an 18 1/2-year reign for the 79-year-old Greenspan under which he raised interest rates 40 times and cut them on 46 occasions.
Greenspan was feted by his Fed colleagues Tuesday with a luncheon of grilled salmon and chocolate cake, and received one of the chairs he used during his tenure as a farewell gift.
Greenspan’s plans include book writing, economic consulting and speaking engagements -- perhaps using clearer language than he provided during a turn as one of the world’s most powerful men.
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Outlook for other interest rates
Here is where some key interest rates stand and the outlook after the Federal Reserve’s latest boost in its benchmark short-term rate from 4.25% to 4.50%.
Item: Prime lending rate
Current rate: 7.50%
Outlook: Major banks raised the prime a quarter point Tuesday, matching the Fed’s rate increase, as they usually do. The prime is a benchmark for many consumer loans such as home equity credit lines. When the Fed stops raising rates, the prime also is likely to top out.
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Item: Money market fund yield (seven-day average)
Current rate: 3.72%
Outlook: Until the Fed stops raising rates, money fund yields also are likely to keep climbing. The funds usually track Fed rate changes with a lag of six to eight weeks, so the average yield should be near 4% by late March.
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Item: One-year CD yield (U.S. average)
Current rate: 3.48%
Outlook: Certificate of deposit yields may continue to edge higher with the Fed’s latest rate hike, but the pace of increase typically has been much slower than with money market funds.
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Item: 10-year Treasury note yield
Current rate: 4.52%
Outlook: Bond yields take their cue from the economy’s strength and the outlook for inflation. Many analysts believe the relatively low level of long-term interest rates is a sign that investors believe the economy will slow this year.
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Item: 30-year mortgage rate (Freddie Mac average)
Current rate: 6.12%
Outlook: Mortgage rates generally follow long-term bond yields and also depend on the strength of loan demand. A slowing economy could keep downward pressure on mortgage rates.
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Sources: Informa Research Services, IMoneyNet, Bloomberg News
Graphics reporting by Tom Petruno
