Fed Hikes Rates To Slow Inflation Quarter-Point Increase May Be First Of Several This Year

The Federal Reserve nudged interest rates higher Tuesday for the first time in two years, hoping to stifle any threat of rising inflation. Banks immediately began raising the rates paid by millions of Americans.

Analysts suggested the Fed’s quarter-point increase was not the end of the story, with two or three more boosts likely by the end of the year to slow the surprisingly strong economy.

The central bank characterized its increase as “a prudent step” that would guard against higher inflation and the risk of recession.

But critics were unswayed, charging that there is no inflation to pre-empt and the central bank’s credit tightening actually raised the risks of recession.

“In one fell swoop, the Fed has taken money out of the pockets of every family, small business and farm in America,” said Sen. Tom Harkin, D-Iowa, a frequent Fed critic.

Financial markets, which had reacted violently in 1994, the last time the central bank launched a round of credit tightening, were much calmer this time around.

In fact, the Dow Jones industrial average actually was up 50 points a few minutes after the 2:14 p.m. announcement as investors expressed relief that the central bank had carried through on the numerous signals sent recently by Federal Reserve Chairman Alan Greenspan. The Dow finished the day down 29.08 at 6,876.17.

The central bank said it was pushing its target for the federal funds rate, the interest that banks charge each other, up to 5.25 percent. It left its largely symbolic discount rate unchanged.

Citibank, the nation’s second-largest bank, and Banc One of Ohio were the first major banks to signal increases in their prime lending rate, pushing it up a quarter-point to 8.5 percent. Other banks were expected to follow.

The prime is used by many banks to peg rates for credit cards, auto loans, home equity loans and adjustable rate mortgages. In recent years it has moved in step with changes in the Fed’s funds rate.

The central bank had left the funds rate unchanged since Jan. 31, 1996, when it had been cut a quarter-point to 5.25 percent. The rate had not been increased since Feb. 1, 1995, when it was pushed to 6 percent in an effort to slow the economy enough to keep inflation under control.

That effort to engineer an economic “soft landing” worked, and the current expansion entered its seventh year this month, third longest in U.S. history.

In its statement, the central bank said Tuesday’s increase had been taken “in light of persisting strength in demand, which is progressively increasing the risk of inflationary imbalances.”

Many economists believe economic growth could be as high as 4 percent in the current quarter, almost double the rate the central bank has been aiming for at this stage of the expansion with factories at high operating levels and unemployment at a seven-year low.

Many analysts cautioned that this rate increase will not be the last, although they were split on how many rate hikes it will take to slow growth to a more acceptable level.

David Jones, economist at Aubrey G. Lanston & Co., said he was looking for two more quarter-point moves occurring by August, at which time he said the Fed would probably be content to sit back and see whether it had done enough.

The Clinton administration, which has made cordial relations with the Federal Reserve a hallmark of its economic policy, was restrained in its reaction.

“We share the goal of maintaining solid economic growth with low inflation,” Treasury Secretary Robert Rubin and Council of Economic Advisers Chairman Janet Yellen said in a joint statement.

But the National Association of Manufacturers, a major business lobbying organization, was sharply critical.

“It is a regrettable and serious mistake,” said NAM Vice President Paul Huard. “It will impede economic growth and make life tougher on consumers and job-creating businesses.”