June 30, 2006 in Business

Fed raises rates again, but keeps options open

Associated Press The Spokesman-Review
 

WASHINGTON — A Federal Reserve interest rate quiz.

In the coming months, Chairman Ben Bernanke and his colleagues will:

(a) Leave rates alone.

(b) Order another rate increase, then take a break.

(c) Keep boosting rates.

Correct answer: It could be any of the above. It all depends on economic activity and inflation in the months ahead.

The Federal Reserve hoisted interest rates to their highest point in more than five years Thursday. While trying to keep their options open about any future decisions, Fed policymakers did raise hopes that a respite from two years of rate pain may be in sight. Wall Street rallied, breathing a sigh of relief.

The Dow Jones industrial average soared 217.24 points to 11,190.80, its biggest single-day jump in more than three years.

Wrapping up a two-day meeting, Chairman Ben Bernanke and other Fed policymakers didn’t rule out another bump in rates. But they seemed hopeful that a slowing economy would lessen pressure on prices, leaving open the question of whether more increases would be needed to declare victory in their battle against inflation.

Fed policymakers said “the extent and timing” of any additional rate increases would hinge on how inflation and economic activity unfold.

They also dropped a phrase — contained in a statement issued at their last meeting on May 10 — that further interest rate increases “may yet be needed” to fend off inflation.

That omission — along with observations that economic growth was slowing — was viewed by some investors and economists as the Fed striking a slightly less hawkish tone about the future course of interest rates.

The Fed’s goal is to raise interest rates enough to keep inflation in check but not so much as to hurt economic activity.

To fend off inflation, the Fed unanimously decided on Thursday to increase its federal funds rate by one-quarter percentage point to 5.25 percent. It marked the 17th increase of that size since the Fed began to tighten credit in June 2004.

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 and is the Fed’s primary tool for influencing economic activity.

In response, commercial banks raised their prime lending rate — for certain credit cards, home equity lines of credit and other loans — by a corresponding amount, to 8.25 percent.

The actions left both the funds rate and the prime rate at their highest points in more than five years.

Analysts had mixed opinions on whether rates would go up again at the Fed’s next meeting, Aug. 8.

“With 17 straight increases now under its belt, is the work of the Federal Reserve finally done? Very possibly,” said Bernard Baumohl, executive director of the Economic Outlook Group, a consulting firm. The Fed’s statement “did not rule out another increase, but it did suggest that the economy was clearly slowing and all that was left at this point is to see how quickly it will be followed by lower inflation,” he said.

Some economists predicted the Fed might boost rates again in August or maybe again in September, then stop for a while to assess how the economy is doing. Some analysts said they were now far less certain another rate increase would come.

“My sense is that they’ll get more information that the economy is slowing by August and they will pause,” said Mark Zandi, chief economist at Moody’s Economy.com.

The economy grew at a brisk 5.6 percent pace in the first quarter of 2006, the fastest in 2 1/2 years. But activity in the current April-to-June period is expected to clock in at about half that pace — from around 2.5 percent to 3 percent, analysts predict. High energy prices and a cooling housing market figure prominently in forecasts for a slowdown.

Job growth lost momentum heading in the summer. Employers boosted payrolls by just 75,000 in May, the fewest new jobs since October. The government’s employment report for June is released next week.

Against this backdrop, Fed policymakers, in their statement Thursday, observed that “recent indicators suggest that economic growth is moderating from its quite strong pace earlier this year, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.”

Although moderating economic growth “should help to limit inflation pressures over time … some inflation risks remain,” the Fed concluded.

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