Reuters Finance News
Fed Raises Rates to Quell Inflation
By Knut Engelmann Nov 16 5:48pm ET
WASHINGTON (Reuters) - The Federal Reserve raised key short-term interest rates on Tuesday to stamp out the threat of higher inflation in the booming U.S. economy and signaled this would be the last increase for a while.
But in its usual even-handed way, the powerful U.S. central bank also warned that the world's biggest economy still was at risk of overheating unless sizzling growth rates level off soon and the nation's exceedingly tight labor market relaxes a bit.
The decision takes the federal funds rate on overnight loans between banks to 5.5 percent from 5.25 percent, the level it was before the Fed's three rapid-fire rate cuts last year.
To amplify its move -- this year's third and, most likely, last rate rise -- the Fed also increased the discount rate on direct Fed loans to banks to 5.0 percent from 4.75 percent.
Financial markets, which had fretted for weeks over the meeting's outcome, greeted with relief what most investors saw as a deft move to keep the economic boom alive just months before it becomes the longest U.S. expansion in history.
Stock prices as measured by the Dow Jones industrial average rose strongly, closing 1.59 percent higher as optimism grew that no more Fed rate rises are in store before the new millennium. The Nasdaq composite and the Standard and Poor's 500 indices both closed at record highs.
But bond prices, hurt by the Fed's warning over the continued risk of overheating, ended the day in negative territory.
TRICKLE-DOWN TIGHTENING
''Today's increase in the federal funds rate, together with the policy actions in June and August and the firming of conditions more generally in U.S. financial markets over the course of the year, should markedly diminish the risk of inflation going forward,'' the Fed said in a statement.
It added that it had changed its monetary policy stance -- a crude signal known as its bias -- to neutral from tightening, indicating it does not expect to move again any time soon.
The Fed's move quickly trickled through the nation's vast financial system. Leading commercial banks wasted no time to bump up their so-called prime rates, the rates they charge on loans to their top customers but which also determine the cost of borrowing to the vast majority of their regular clients.
''If there were any doubts about the Fed's credibility on fighting inflation, these moves erase them,'' said Anthony Chan, chief economist at Banc One Investment Advisors in Columbus, Ohio. ''It ensures that the expansion will last longer because they are taking care of a problem before it develops.''
But while the Fed expressed confidence that its strategy would help keep inflation at bay, it added a cautionary note.
''Despite tentative evidence of a slowing in certain interest-sensitive sectors of the economy and of accelerating productivity, the expansion of activity continues in excess of the economy's growth potential,'' it said.
BYE-BYE, GOLDILOCKS?
Echoing long-standing warnings by Chairman Alan Greenspan, the Fed said the U.S. economy could easily run out of workers if that trend was not reversed soon.
''The Fed clearly did it because they are worried that the economy is running a little bit too hot,'' said Cynthia Latta, economist at Standard & Poor's/DRI.
The nation's unemployment rate stands at 4.1 percent, its lowest level in more than a generation. The economy expanded at a red-hot pace of 4.8 percent in the year's third quarter.
While headline inflation numbers have so far displayed few danger signs, many economists have warned that underlying costs -- such as commodity prices -- are slowly moving up.
More detailed news on the inflation front is expected on Wednesday with the release of the October consumer price index. Tuesday's move followed a quarter-point rise in the fed funds rate in both June and August. At its most recent meeting in October, the Fed left rates unchanged but said it had moved to a tightening bias, signaling its next move was likely up.
While the Fed news was applauded in financial markets, it angered key U.S. business groups worried about the effect of higher borrowing costs on company balance sheets.
''They clearly had room to wait,'' said Martin Regalia, chief economist at the Chamber of Commerce. ''If this were a football game, they would draw a penalty flag for 'piling on'.''
THAT'S ALL, FOLKS
The U.S. administration, as usual, refrained from commenting on the decision other than saying in a brief statement that it respected the Fed's independence and shared its goal of maintaining healthy growth with low inflation.
Fed policymakers are next scheduled to discuss U.S. borrowing costs at the final meeting of the Federal Open Market Committee this year on Dec. 21.
But many economists doubt they will run the risk of adding to potential upheavals from the Year 2000 computer problem, which would most likely put off any rate rises at least until Feb. 1-2, next year's first FOMC meeting.
''My feeling is that the Fed perhaps is finished hiking rates into the foreseeable future,'' said John Lonski, chief economist at Moody's Investors Service in New York.
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