By Martin Wolk Executive business editor
msnbc.com
updated 3/28/2006 4:27:02 PM ET 2006-03-28T21:27:02

New chairman, same result.

The Federal Reserve raised interest rates another quarter-point Tuesday as Chairman Ben Bernanke extended the policy of tighter credit initiated by his predecessor Alan Greenspan.

The move had been widely expected, but stock prices fell sharply afterward as Bernanke and his colleagues made clear in a statement that they expect to raise rates at least once more, probably at the next meeting of policy-makers May 10. The Dow Jones industrial average, which had been in positive territory when the rate hike was announced, closed with a loss of 96 points, or nearly 0.9 percent.

"The key thing here is that there were a minority of investors who were hoping the Fed would signal they are nearly done and give them a maybe-we're-winding-down kind of statement, and they didn’t do that," said Ethan Harris, chief U.S. economist for Lehman Bros.

The latest move pushed the benchmark overnight lending rate to 4.75 percent, the highest level in five years, and marked the 15th straight time Fed policy-makers have raised rates. Commercial banks quickly followed the Fed by raising their prime rate — charged to top business and individual customers for short-term credit — to 7.75 percent.

Bernanke at Fed
AFP - Getty Images
Federal Reserve Chairman Ben Bernanke, who was sworn in Feb. 1, is shown presiding over his first meeting of policy-makers this week in a photo released by the central bank.
"Economic growth has rebounded strongly in the current quarter but appears likely to moderate to a more sustainable pace," the Fed said in a statement announcing the move. The Fed said "inflation expectations remain contained," but policy-makers still see factors with the "potential to add to inflation pressures."

As a result, the Fed repeated language it used after its final meeting under Greenspan Jan. 31, saying "some further policy firming may be needed" to keep the economy growing without fueling inflation. The comment has been widely interpreted as suggesting at least one more rate hike is likely.

Some investors were hoping that the Fed would soften the language to suggest that the central bankers were prepared to step to the sidelines, depending on the economy's performance in coming weeks, analysts said.

Instead, the Fed simply moved the debate a bit further into the future.

"Basically, the new boss has the same worries as the old boss, and maybe moreso," economist Joel Naroff of Naroff Economic Advisors said in a written commentary. "For the markets, this cannot be good news. Investors were hoping there would be some indication that the tightening cycle would be coming to an end. Their hopes were dashed."

Many forecasters still expect the central bank to pause once the benchmark rate hits 5 percent, but Harris is skeptical and believes the rate will go to 5.5 percent before the year is over.

Major Market Indices

"The Fed is focused on inflation risks, and inflation risks have not gone away," he said. "Any sign of a pickup in inflation — that is kind of the final straw and will be enough to prolong the tightening cycle more than people think."

The Fed did introduce new language into its policy statement, basically outlining the risks and guideposts policy-makers will watch as they determine whether to continue raising rates or move to the side.

John Silvia, chief economist of Wachovia Corp., said that while the Fed is concerned about the possibility of wage inflation, the statement makes clear that central bankers will look at wages in conjunction with productivity and resource utilization. Rising wages are not necessarily a problem as long as productivity is rising too, he pointed out.

"It's a nuanced development and very good to see," Silvia said.

In its statement, the Fed also emphasized that the economy is slowing from its unusually strong growth rate in the first quarter, which economists estimate at 4.5 percent, to what it described as a "more sustainable pace." Silvia said that gave him confidence in his view that the central bank will halt after it pushed the federal funds rate to 5 percent in May.

But Oscar Gonzalez, an economist with John Hancock Financial Services, said the Fed commentary "didn't shed any light as to what they are going to do in the future."

"They left the forward-looking part of the release exactly the same way," he said. A rate hike in May is "almost a given at this point," he said.

The Fed began its current campaign under Greenspan in June 2004 — when rates were at a 46-year low — to keep the economy from picking up too much strength and sparking a run-up in inflation. Economists and forecasters believe the Fed is nearing the end of the rate-hike cycle, but so far Bernanke and other central bankers have offered few hints on when they might be prepared to pause.

After nearly two years, the moves are clearly having an impact, pushing up long-term mortgage rates and raising the costs of everything from home equity loans to business lines of credit. But the economy is still growing at a steady pace of about 3 to 3.5 percent, employers are adding to their payrolls and inflation is creeping toward the upper end of the central bank's comfort range.

Even as the housing market slows, consumers are becoming more confident about the economy's prospects, according to a widely watched monthly survey released Tuesday.

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