msnbc.com staff and news service reports
updated 1/5/2005 1:00:51 PM ET 2005-01-05T18:00:51

Federal Reserve policy-makers plan to continue pushing interest rates higher to head off the risk of an inflation flare-up, according to minutes of their latest meeting released Tuesday.

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The central bank's rate-setting Federal Open Market Committee met Dec. 14 and raised its benchmark interest rate a quarter percentage point for the fifth time in six months.

But according to the minutes, Fed officials believed that more rate hikes will be needed.

“Even with this action, the current level of the real funds rate target remained below the level it most likely would need to reach to keep inflation stable and output at its potential,” according to the minutes.

The Fed's reported concern over inflation sent stock prices sharply lower on Tuesday and confirmed for many investors and analysts that the central bank will ratchet its benchmark rate higher again when the FOMC concludes its next meeting Feb. 2.

“The message in the Fed minutes is clear: more Fed tightening to come,” said Stuart Hoffman, chief economist at PNC Financial Services Group.

The minutes were the first to be released under a new policy to speed up publication by issuing minutes three weeks after each regular meeting, giving market participants better insight into the current thinking of central bankers.  Previously minutes were not issued until after the FOMC had held another meeting and announced its decision on rates.

“A number of participants cited the recent depreciation of the dollar on foreign exchange markets, elevated energy costs and the possibility of a slowing in underlying productivity growth as factors tending to boost the upside risks to their inflation outlook,” according to the  minutes of the Dec. 14 meeting.

The document added: “On net, (Fed officials) saw the risks to stable underlying inflation as still balanced.”

But financial investors appeared to be interpreting the Fed’s comments in the minutes as a possible signal of bolder rate increases, economists said.

“The markets are starting to fear a more aggressive Fed in 2005,” said Richard Yamarone, director of economic research at Argus Research.

The minutes said some meeting participants also felt the prolonged stretch of cheap credit may have prompted ”potentially excessive” risk-taking in financial markets — citing narrow credit spreads, as well as an increase in initial stock offerings, mergers and speculative demand in the residential real estate market.

“Basically what they’re saying is that given the rate in the bond market, people are taking excessive risk,” said Christopher Low, chief economist at FTN Financial in New York. “Some members said the economy is close to potential, which suggests we might soon see inflation pressures take hold. All in all, I’d say it’s considerably more hawkish than what we’ve seen.”

Clearer rate signals
Paresh Upadhyaya, a portfolio manager for Putnam Investments, said the report suggests the Fed is "on track to hike over the next several meetings,” adding this would likely bolster the dollar’s value.

The minutes cited several developments "that could pose upside inflation risks.”

Even though oil prices have moderated, they remain above levels in early 2004 and that, along with a cheaper dollar, makes imports more costly, which could reduce competitive pressures on many industries.

One factor that has helped keep U.S. inflation low is a reluctance by companies to push prices up for fear of losing customers. So businesses have sought to keep profits up by trimming costs in other areas, but those savings are limited.

“A few participants also noted that uncertainty about the extent of resource slack in the economy was considerable and that it was possible the economy could soon be operating close to potential,” the minutes said.

In explaining the decision to release their minutes more quickly, Fed officials suggested investors might get more insight about the future course of interest rate policy.

Members said the minutes contained “a more complete and nuanced explanation of the reasons for the committee’s decisions and view of the risks to the outlook than was possible in the post-meeting announcement, and their earlier release would help markets interpret economic developments and predict the course of interest rates.”

The minutes are available at the Fed's Web site.

Reuters and The Associated Press contributed to this report.

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