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Fed mulled half-point hike at last meeting

Worried about the potential for inflation to get worse, Federal Reserve policy-makers at their May meeting considered raising a key interest rate by half a percentage point before opting for a quarter-point increase.
/ Source: The Associated Press

Worried about inflation, Federal Reserve policymakers at their May meeting considered raising a key interest rate by half a percentage point before opting for a quarter-point increase.

Chairman Ben Bernanke and his Fed colleagues also decided to leave the door open to additional rate increases “in view of the risk that the outlook for inflation could worsen,” according to minutes of the Fed’s May 10 closed-door meeting released Wednesday.

Those minutes showed that Fed officials discussed a number of options — ranging from leaving rates unchanged to boosting them by a half percentage point. Policymakers mulled these options as they weighed whether it was more likely that the economy would slow given the Fed’s previous rate increases or whether soaring energy prices might touch off broader inflation. Then they approved the quarter-point increase, the 16th consecutive hike of its kind.

That unanimous decision boosted the federal funds rate to 5 percent, the highest level in 5 years. The Fed had started the campaign to tighten credit in June 2004.

Policymakers deemed that action appropriate “to keep inflation from rising and promote sustainable economic expansion,” according to the minutes.

The funds rate, the interest that banks charge each other on overnight loans, affects a variety of other interest rates charged to consumers and businesses. It is the Fed’s primary tool for influencing economic activity.

The Fed said “a number of factors were augmenting the upside risks to inflation” including a run up in energy prices as well as some commodity prices and a weaker value of the U.S. dollar. A weaker dollar can raise the prices of imports flowing into the United States and thus can give U.S. producers more leeway to boost their own prices.

In late April, oil prices hit a record high of more than $75 a barrel. Gasoline prices also marched higher, topping $3 a gallon in some areas.

“Inflation pressures appeared to be somewhat greater than the committee had anticipated” when it gathered for its previous meeting in March, the minutes said.

While acknowledging some “downside risks to economic activity,” policymakers believed the most likely course was that the economy would moderate gradually over coming quarters, which would help restrain inflation pressures.

Looking ahead, though, the Fed was not clear what its next move might be.

“Given the risks to growth and inflation, committee members were uncertain about how much, if any, further tightening would be needed” after the May increase, the minutes said.

Against that backdrop, the Fed at the May meeting left its options for future rate decisions wide open. The board suggested another rate increase could be in store to fend off inflation or it could take a pause in its two-year rate-raising campaign if economic growth moderates.

Economists have mixed opinions of what the Fed might do at its next meeting, June 28-29. Some economists believe it will boost rates for a 17th time; others think it may take a temporary breather. In either case, most think the Fed will probably end its rate-raising campaign this year.

“If they were even discussing an aggressive half-point move, clearly inflation is disturbing some members around the table,” said Richard Yamarone, economist at Argus Research. “Still, it was not uncommon for the Fed — at least under (former Chairman Alan) Greenspan — to end a tightening campaign with a bold half-point increase,” he noted.

The minutes also revealed that Bernanke had appointed a panel to explore ways the Fed can improve the way it communicates with Wall Street and Main Street. The panel is chaired by Fed governor Donald Kohn.

Bernanke, who took over the Fed helm on Feb. 1 after longtime chairman Greenspan retired, has gotten off to a bumpy start in his own way of communicating with financial markets, economists say.

On other issues, Fed policymakers said a cooling in the once red-hot housing market was especially noticeable for high-end homes and for houses in markets that had experienced the steepest run-up in home prices. Speculative home building appeared to have dropped off considerably, although inventories of unsold homes were still expanding, the minutes said.

Although risky mortgages have the potential to cause financial difficulties for some households, the financial health of most households was likely to remain sound, the minutes said.

Policymakers also noted that a surge in federal tax revenues was likely to help trim the federal budget deficit considerably. Still, the deficit over the longer run “remained a serious concern.”