updated 9/21/2005 12:26:00 PM ET 2005-09-21T16:26:00

The decision of the Federal Reserve to keep raising interest rates in the face of a devastating hurricane means one thing to many economists: Rates will keep going up and are likely to head higher than previously expected.

Major Market Indices

Analysts saw the quarter-point rate increase by the Fed on Tuesday and the explanation for why it was needed as a clear signal that the central bank is growing more concerned about inflation.

The Fed pushed its target for the federal funds rate, the interest that banks charge each other, up for the 11th time in the past 15 months, raising it to 3.75 percent. That was the highest level since August 2001.

In response, commercial banks began raising their prime lending rates by a corresponding amount, to 6.75 percent, the highest in more than four years. These rates are used for many short-term consumer loans, including some credit cards and popular home equity lines of credit.

The Fed’s rate increase came even though some analysts had suggested it might pause to allow time to see how big a hit the economy would sustain from Hurricane Katrina, the country’s costliest natural disaster.

Instead, Federal Reserve Chairman Alan Greenspan and his colleagues said Katrina’s widespread devastation would not prove to be a “persistent threat” to the economy.

However, the central bank did worry about the persistent rise in energy prices this year, including a renewed surge after Katrina shut down Gulf Coast oil and natural gas production.

“Higher energy and other costs have the potential to add to inflation pressures,” Fed officials said in the statement explaining their latest move.

Many analysts said that statement and the Fed’s decision to go ahead with another rate increase showed the central bank will be focusing in coming months on what it perceives as its primary mission — making sure inflation pressures do not get out of control.

Analysts said Fed officials raised interest rates at this meeting even though they know that the economy is going to show some significantly weaker statistics over the next month.

“If you raise interest rates in the face of what you know will be some pretty awful economic numbers, you must have a lot of confidence about the economy’s ultimate recovery and a lot of concern about inflation,” said Lyle Gramley, a former Fed board member and now senior economic adviser at Schwab Washington Research Group.

Many economists are forecasting that Katrina will slash as much as a full percentage point off growth in the second half of this year and trim job growth by as much as 400,000 over the next four months.

However, private analysts agree with the Fed’s assumption that the effects will be temporary, with the weakness this year followed by higher growth next year, reflecting what could be $200 billion spent on recovery and rebuilding efforts.

All that spending will have a stimulative effect on the economy and is likely to further raise worries about inflation at the Fed.

“Washington will pump massive amounts of aid into the Katrina-affected areas boosting economic activities,” said economist Sung Won Sohn, president of Hanmi Bank in Los Angeles.

The Fed began raising rates in June 2004 at a time the federal funds rate was at a 46-year low of 1 percent.

Its goal has been to raise the funds rate to a neutral level where it is neither stimulating nor depressing economic growth. While it has never said what that neutral level is, many analysts have said they believe it is somewhere between 4 percent and 4.5 percent.

However, based on the Fed’s comments on Tuesday, some analysts said they are raising their expectations for where the Fed might stop. Gramley said he would not be surprised to see a funds rate at 5 percent or even higher next year.

Other analysts said they believed the Fed would pause sooner, but not before raising rates at Greenspan’s final three meetings on Nov. 1, Dec. 13 and Jan. 31, meaning a funds rate of 4.5 percent at the end of January.

That would mean significant increases in consumer rates as well since banks’ tie their prime lending rate to moves in the federal funds rate.

While 30-year mortgage rates have stayed below 6 percent for most of this year at some of the lowest rates in four decades, that is expected to be coming to an end. The current 5.74 percent for a 30-year mortgage is forecast to be pushing 6 percent by the end of this year and could be around 6.75 percent by the end of 2006.

© 2013 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

Discuss:

Discussion comments

,

Most active discussions

  1. votes comments
  2. votes comments
  3. votes comments
  4. votes comments

Data: Latest rates in the US

Home equity rates View rates in your area
Home equity type Today +/- Chart
$30K HELOC FICO 1.97%
$30K home equity loan FICO 5.80%
$75K home equity loan FICO 4.54%
Credit card rates View more rates
Card type Today +/- Last Week
Low Interest Cards 13.70%
13.70%
Cash Back Cards 17.91%
17.91%
Rewards Cards 17.17%
17.17%
Source: Bankrate.com