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Fed raises rates another quarter-point

The Federal Reserve raised short-term interest rates a quarter-point for the fourth time in five months, extending its campaign to keep inflation in check after a report showing impressive job growth.
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The Federal Reserve raised short-term interest rates a quarter-point for the fourth time in five months Wednesday, extending its campaign to keep inflation in check after the economy showed impressive job growth over the past three months.

The decision by Fed Chairman Alan Greenspan and other central bank policy-makers, which was widely expected, brings the overnight federal funds rate to 2 percent, up from 1 percent in June when the Fed began raising the benchmark from its lowest level in 46 years.

"Output appears to be growing at a moderate pace despite the rise in energy prices, and labor market conditions have improved," the Fed said in a statement explaining the decision.

Fed officials appeared slightly more upbeat than they were Sept. 21, when the central bank said in a statement that "output growth appears to have regained some traction, and labor market conditions have improved modestly."

Joel Naroff of Naroff Economic Advisors said the latest statement makes it "almost a certainty" the central bank will raise the funds rate by another quarter-point at its next meeting Dec. 14, although other economists are divided on the question. But given the recent evidence of strong job growth, most analysts agree the Fed's policy-setting Federal Open Market Committee is not finished with the rate-hike campaign.

"Eventually, the Federal Reserve will reach the neutral rate of 3.5 to 4 percent," Wells Fargo chief economist Sung Won Sohn said in a written commentary. "How rapidly the FOMC moves will depend on the economy and inflation."

The central bank is slowly but steadily raising borrowing costs for consumers and businesses after a period of unusually low rates. The prime rate, a benchmark commercial rate that rises in lockstep with the federal funds rate, was raised by major banks to 5 percent from 4.75 percent after the Fed's move.

But long-term interest rates, including 15- and 30-year mortgage rates, actually have fallen since June in a reflection of concern about a slowdown in economic growth. As the Fed continues to raise rates, it is all but inevitable that long-term rates will rise, analysts say.

The latest move brings the federal funds rate above the core rate of inflation for the first time since the terrorist attacks of Sept. 11, 2001, said Michael Wallace, global market strategist for Action Economics. The 9/11 attacks triggered a series of emergency rate cuts from a Fed already in the midst of an aggressive effort to boost the flagging economy.

In June of this year, the Fed began removing the accommodation at what it described as a "measured" pace, even though job growth was far below what was typical for an economy that was well into the recovery phase. A surge in oil prices contributed to what Greenspan called a "soft patch" in the economy, but Fed policy-makers continued raising rates at every scheduled meeting.

Some analysts believe the Fed will continue that pattern through the end of next year, which would bring the federal funds rate to 4.25 percent, but others expect the Fed to pause at some point to reassess the economy. Sohn cautions that sentiment "could turn on a dime," depending on external shocks such as terrorist attacks or unrest that sends oil prices higher.

"The Federal Reserve does not have as much control over the economy as it used to," Sohn said.

Futures traders say a rate hike in December is a 79 percent probability, down slightly from 83 percent before the Fed statement was issued in mid-afternoon Eastern time. Broad stock market indexes ended little changed.

On Friday, the Labor Department reported that U.S. employers added 337,000 jobs in October, the best performance in seven months. Including an upward revision to previous figures, the report indicated the economy has added an average of 225,000 jobs a month over the past three months, substantially more than needed to absorb the number of new workers entering the labor force.

The report made this week's rate hike a certainty in the minds of financial market participants.

Analysts and economists are far from agreement on when the Fed is likely to step to the sidelines or at least pause in its rate-hike campaign. Some speculate that Greenspan would like to finish hiking rates soon to set the Fed on a steady path ahead of his scheduled retirement in early 2006.

Full text of Fed statement
The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 2 percent.

The Committee believes that, even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. Output appears to be growing at a moderate pace despite the rise in energy prices, and labor market conditions have improved. Inflation and longer-term inflation expectations remain well contained.

The Committee perceives the upside and downside risks to the attainment of both sustainable growth and price stability for the next few quarters to be roughly equal. With underlying inflation expected to be relatively low, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.

Voting for the FOMC monetary policy action were: Alan Greenspan, Chairman; Timothy F. Geithner, Vice Chairman; Ben S. Bernanke; Susan S. Bies; Roger W. Ferguson, Jr.; Edward M. Gramlich; Thomas M. Hoenig; Donald L. Kohn; Cathy E. Minehan; Mark W. Olson; Sandra Pianalto; and William Poole.

In a related action, the Board of Governors unanimously approved a 25 basis point increase in the discount rate to 3 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, and Kansas City.