The Federal Reserve raised short-term interest rates a quarter-point for the 10th time in 14 months Tuesday and indicated that more rate hikes are likely because of inflation pressures stemming from the briskly growing economy.
As widely expected, Fed Chairman Alan Greenspan and his fellow policy-makers raised the benchmark overnight lending rate to 3.5 percent, compared with a 46-year low of 1 percent in June 2004 when the Fed began raising rates. Major commercial banks quickly followed by raising the prime rate for the most creditworthy businesses and consumers to 6.5 percent.
The Fed repeated language it has used consistently over the past year to signal further rate hikes, supporting the case of analysts who expect the central bank to continue tightening credit at the same steady pace, bringing the overnight rate to at least 4 percent by the end of the year.
"The end of the tunnel is not in sight," said Ethan Harris, chief U.S. economist for Lehman Bros. "Basically they are saying the same thing each meeting, meaning, 'We don’t have an estimate for when we're finished.'"
Policy-makers believe "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," the Fed said in a statement. "Core inflation has been relatively low in recent months and longer-term inflation expectations remain well contained, but pressures on inflation have stayed elevated."
The statement went on to say that "policy accommodation can be removed at a pace that is likely to be measured," language that in the past has signaled quarter-point rate hikes.
The steady string of quarter-point moves, which have become almost routine, is unprecedented in the recent history of the Federal Reserve. In the past, rapidly changing economic conditions have forced the central bank to respond more aggressively by making moves of a half-point or more, or by making "extra" moves between scheduled meeting of policy-makers.
This time around, Fed Chairman Alan Greenspan and his colleagues have been able to stick to their word by raising rates in a "measured" fashion, moving exactly a quarter-point at each of the past 10 consecutive scheduled meetings.
There are two more meetings this year, and many analysts now expect the cycle to continue into 2006, even after Greenspan, 79, retires after 18 years in his immensely powerful post. Greenspan's term ends in January and he is not eligible to be reappointed.
Goldman Sachs, for example, this week raised its interest rate projections, forecasting that the Fed will raise the overnight rate to 5 percent by mid-2006, up from a previous forecast of 4.5 percent. Rich Yamarone, director of economic research for Argus Research, set a target of 5.25 percent and noted that Fed officials have suggested that even a half-point rate hike would still be considered "measured."
"At this point in time I guess they have got to have something pretty dramatic to stop them — either a sharp deceleration in inflation or a sharp deceleration in growth," said Diane Swonk, chief economist of Mesirow Financial in Chicago.
The economy grew at a decent 3.4 percent rate in the latest quarter, and many forecasters expect growth to be even stronger in the current quarter. Employers added 207,000 jobs last month, enough to absorb new workers and draw some in from the sidelines, keeping the unemployment rate steady at 5 percent.
On the inflation front, signs are a bit more mixed, with the latest reports showing that inflation was a bit above the Fed's target late last year but has declined a bit since then. Many economists have been surprised that the steady increase in oil and gasoline prices to record levels has not yet had more impact on either inflation or growth.
"The bottom line is we haven't played through all the lags yet," said Swonk.
One major uncertainty has begun to resolve itself as long-term interest rates set on the international bond market have begun to rise in tandem with short-term rates. Over the past two months the yield on the benchmark 10-year bond has risen half a percentage point, pushing fixed mortgage rates steadily higher.
That could help cool the red-hot housing market, which has set off some alarms among policy-makers and analysts who fear the rapid unwinding of an asset bubble could cause a sharp slowdown in overall growth.
"With the household sector dependent on housing wealth to sustain consumer spending, it should only take a relatively modest rise in long-term rates to take the steam out of the housing sector and for this to lead to a significant slowing in consumer spending," Goldman Sachs chief economist said in a note to clients Monday.
When that happens, sometime in the next six to 12 months, consumer spending growth will likely slow, putting an end to the Fed's rate-hike cycle, he said.