New Chief Keeps Fed on Path of Tightening

The chairman was new, but the result was the same: The Federal Reserve nudged its benchmark short-term interest rate up a quarter of a percentage point Tuesday and suggested that at least one more rate increase was coming.

It was the central bank’s 15th consecutive rate hike since June 2004, the first 14 engineered by Alan Greenspan and this one by his successor, Ben S. Bernanke. The so-called federal funds rate, which banks charge each other for overnight loans, now stands at 4.75%, its highest level in five years and up from a historic low of 1% two years ago.

In its statement accompanying the announcement, the unanimous Bernanke Fed repeated language from the Greenspan Fed’s last meeting on Jan. 31 that “some further policy firming may be needed.” That is Fed-speak for more rate increases to fend off inflation.

In wording more upbeat than in its January statement, the Fed’s policymaking committee said “economic growth has rebounded strongly” after slowing at the end of 2005, although the committee added that growth “appears likely to moderate to a more sustainable pace.”

“Inflation expectations remain contained,” the Fed said. “Still, possible increases in resource utilization [that is, less unemployment], in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures.”

With the Fed’s rate move, major banks raised their prime lending rates to 7.75% from 7.5%. Many home equity loans and other consumer loans are pegged to the prime.

The suggestion of further interest rate hikes disappointed stock and bond investors who had hoped for a signal that the Fed’s campaign might be ending.

The Dow Jones industrial average, which was up slightly before the Fed’s 11:15 a.m. Pacific time announcement, dived about 100 points after the news. Bond prices also fell, pushing up yields on all maturities of the fixed-income securities.

During most of the Fed’s prolonged campaign to raise the federal funds rate -- the only interest rate the central bank directly controls -- longer-term rates have not marched higher in tandem with short-term rates.

Consequently, the interest rate on six-month Treasury bills, now 4.82%, has overtaken the rate on 10-year Treasury notes, at 4.78%. Ordinarily, rates are higher on longer-term securities because investors demand more compensation against the possibility that rising inflation will eat some of their returns.

Historically when short-term rates have risen above long-term rates, it often has foreshadowed a recession. But both Greenspan and Bernanke have said they didn’t believe that was the case this time.

Bernanke has vowed to continue the policies of the popular Greenspan, who presided for 18 years until his retirement immediately after the last Fed meeting.

Another quarter-point increase at Bernanke’s first Fed gathering was “as close to a sure thing as you can get,” Bernard Baumohl, executive director of the Economic Outlook Group in Princeton, N.J., said before the Fed announcement.

From here on, the decisions will get progressively trickier. Bernanke does not want to trigger a recession at the beginning of his term by raising rates so high that they choke off economic activity. But he also doesn’t want to be remembered as letting inflation surge because rates were too low.

“With the benchmark rate at 4.75%, the easy work for the Fed is done,” Baumohl said. “From this point on, monetary policy becomes increasingly treacherous.”

So does predicting it. Forecasts vary widely, and Tuesday’s action changed few of them.

Goldman Sachs’ U.S. economics research team stood by its prediction that the next rate increase in May, to 5%, would be the last. Economist Andrew Tilton pointed out that the Fed said economic growth was likely to moderate of its own accord, without any further rate hikes.

“Without a significant pickup in inflation between now and the June [Fed] meeting,” Tilton said, “it is hard to see the fed funds rate moving beyond 5%.”

Not to Lehman Bros. That investment house sees the Fed pausing only after it has pushed its rate up to 5.5% at its August meeting.

John Shin, senior economist at Lehman, cited the economy’s strong growth pace, which he estimated at an annualized 5.5% in the first quarter ending Friday, after the Hurricane Katrina-related slowdown to 1.6% in the final three months of last year.

“With lower unemployment, stronger growth and less excess productive capacity, the labor market should tighten up, pushing up wages and adding to inflationary pressures,” Shin said. “It is a wage-price spiral that the Fed is trying to throw cold water on.”

Partly reflecting rising wages and an improving job market, the Conference Board reported Tuesday that its widely followed consumer confidence index rose to a near four-year high.

Inflationary pressures already are breaking out. Core consumer prices -- excluding the volatile energy and food sectors -- are rising slightly faster than 2% a year, which is believed to be the upper bound of Bernanke’s inflation “comfort zone.”

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(BEGIN TEXT OF INFOBOX)

Statement by Fed on Funds Rate

Here is the statement issued Tuesday by the Federal Reserve about 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 4.75%.

The slowing of the growth of real GDP in the fourth quarter of 2005 seems largely to have reflected temporary or special factors. Economic growth has rebounded strongly in the current quarter but appears likely to moderate to a more sustainable pace.

As yet, the run-up in the prices of energy and other commodities appears to have had only a modest effect on core inflation, ongoing productivity gains have helped to hold the growth of unit labor costs in check, and inflation expectations remain contained. Still, possible increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures.

The committee judges that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance. In any event, the committee will respond to changes in economic prospects as needed to foster these objectives.