*DJ Fed Raises Rates 0.25-Pt To 3.25%; Sees Balanced Risks
*DJ FOMC Sees Likely Measured Pace Of Policy Tightening
*DJ FOMC: Nonetheless, Will Respond To Economy As Needed
*DJ FOMC: Despite Energy Prices, Expansion "Remains Firm"
*DJ FOMC: Labor Mkt Conditions Improving "Gradually"
*DJ Fed: Pressures On Inflation "Have Stayed Elevated"
*DJ Fed: Inflation Expectations Still "Well Contained"
*DJ FOMC: Vote On Federal Funds Rate Hike Was Unanimous
*DJ FOMC: Discount Rate Lifted By 0.25-Pt To 4.25%
=DJ Fed Raises Key Rate For Ninth Time; Says More To Come
By Joseph Rebello
Of DOW JONES NEWSWIRES
WASHINGTON (Dow Jones)--The Federal Reserve raised its key interest rate for the ninth time in a year Thursday and made it clear it isn't finished with one of its longest campaigns of interest-rate hikes in a generation.
Amid signs that surging oil prices didn't slow U.S. economic growth, Fed policymakers voted unanimously to raise the key federal funds rate a quarter percentage point to 3.25%. That's the highest level since just before the terrorist attacks of Sept. 11, 2001.
"Although energy prices have risen further, the (economic) expansion remains firm and labor-market conditions continue to improve gradually," the Fed's Open Market Committee said in a statement. "Pressures on inflation have stayed elevated, but longer-term inflation expectations remain well-contained."
The policymakers indicated they're inclined to raise the funds rate at least once more, as early as Aug. 9, saying the the rate remains too low - "accommodative," in their words. Still, they pledged to lift it at "a pace that is likely to be measured." That phrase so far has signified increases of a quarter percentage point at a time.
The rate increase was expected on Wall Street: all of the primary bond dealers authorized to trade with the Fed saw it coming. Long-term mortgage rates, which declined over the last year even as the Fed was raising the funds rate, are expected to stay low as a result. "The market already factored this in," said Bill Emerson, chief executive of Quicken Loans in Livonia, Mich.
The Fed's decision reflected diminishing worries not only about the outlook for inflation but also about the strength of the U.S. economic recovery. As crude-oil prices climbed to record highs this year, Fed policymakers expressed increasing uncertainty about how they should adjust interest rates: some argued the pace of rate hikes might need to be accelerated to check inflation; others fretted further rate increases could hurt the economy.
The policymakers opted, in the end, to stick with their practice of raising the funds rate a quarter percentage point at the conclusion each of their meetings. The approach paid off: the economy grew a robust 3.8% in the first three months of 2005 - the same rate as in the final quarter of 2004 - despite higher oil prices. Inflation stayed well within the Fed's desired range of 1% to 2%. Job growth remained steady, averaging a healthy 180,000 a month this year.
But after a year of steady rate increases, Fed policymakers are approaching a turning point. The rate-hike campaign already is the second-longest of the Alan Greenspan era - it will become the longest if the FOMC opts to raise the rate again at its next meeting on Aug. 9. The funds rate would then be 3.5%, the lower limit of the zone Fed policymakers consider to be "neutral" for the economy - neither stimulative nor restrictive.
Because Fed policymakers can't agree on precisely what constitutes a neutral funds rate - their estimates go as high as 5% - they say they intend to proceed much more carefully beyond that point. Last month, one policymaker, Richard Fisher of the Dallas Fed, said explicitly the central bank might stop raising interest rates.
"We're clearly in the eighth inning of a tightening cycle," Fisher said in an interview with CNBC, comparing the Fed's actions over the last year to the nine innings of a baseball game. "We have the ninth inning coming up at the end of June." But because inflation is still a risk, he said, the Fed may opt to go into "extra innings."
Other FOMC members have been more cautious, saying they need to keep their options open. "Once the funds rate target is back within the neutral range, I believe the Federal Reserve will be better positioned to achieve its long-run inflation goals while maintaining the flexibility to address signs of weaker economic activity," Thomas Hoenig, of the Kansas City Fed.
The caution reflects the belief of many policymakers that they're operating in what Fed Governor Donald Kohn has called "uncharted territory." Yields on long-term bonds, which typically rise in response to Fed rate increases, have fallen over the last year - a "conundrum," according to Greenspan, with contradictory implications for the Fed.
That could mean that the funds rate needs to rise further to check inflation. Or it could mean the rate already is too high - because history shows an economic slump usually ensues when long-term yields drop below the funds rate.
Moreover, the existence of what Greenspan has called "froth" in the U.S. housing market poses a hazard for Fed policymakers. Last week, an organization of central bankers, the Bank for International Settlements, warned that the U.S. economy has "arguably become overdependent on consumer spending, borrowing and the extraction of equity from housing wealth." Decisions to raise interest rates will have to be made "with some delicacy," it said.
Under the circumstances, analysts say, the Fed's decisions after August will become less predictable and more dependent on the latest data about the state of the economy. "The Committee will be aware that the funds rate could already be at the neutral level, and will allow the data to inform it whether the neutral funds rate is, in fact, higher," former Fed Governor Laurence Meyer, now a private forecaster, said in a note to clients last week. "During that process, pauses are more likely..."
Futures contracts show investors have a similar view. The contracts show the funds rate will not be higher than 3.75% by the end of 2005. Because the FOMC meets four more times this year, that implies investors think a "pause" is inevitable after August. The FOMC, most analysts say, will not stick to its current practice of raising the rate at every one of its meetings.
On Thursday, the Fed's Board of Governors also opted to raise the largely symbolic discount rate by a quarter percentage point to 4.25%.
-By Joseph Rebello; joseph.rebello@dowjones.com
-Deborah Lagomarsino and Campion Walsh contributed to this
report.
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