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Interest Rate

Posted on: May 3, 2005

The Associated Press/WASHINGTON

By JEANNINE AVERSA
AP Economics Writer

End not in sight for interest rate hikes

MAY. 3 5:33 P.M. ET The Federal Reserve, worried about climbing inflation, pushed a key interest rate higher Tuesday and signaled that Americans’ borrowing costs are likely to keep climbing in the months ahead.

In response, commercial banks began lifting their prime lending rates, which are used for many short-term consumer and business loans.

Federal Reserve Chairman Alan Greenspan and his colleagues, sticking to a course of gradually raising rates, nudged up the federal funds rate by one-quarter of a percentage point, to 3 percent. It was the eighth increase of that size since the Fed began to tighten credit last June, and it left the rate at the highest level since the fall of 2001.

Banks’ prime lending rates were rising a quarter-point to 6 percent, also the highest since 2001.

The federal funds rate, the interest banks charge each other on overnight loans, is now triple the 1 percent rate — a 46-year low — that prevailed before the Fed embarked on its rate-raising campaign.

Fed policy-makers, walking a tightrope, are confronted with two challenging economic forces: rising inflation pressures on the one hand and slowing economic growth on the other.

Higher interest rates are a defense against rising inflation. But when it is more expensive to borrow money, some consumers and businesses are less inclined to spend and invest, factors that would further chill an already cooling economy.

The policy-makers, in a brief statement issued after their closed-door meeting, acknowledged that the economy had hit a rough patch in early spring. "The solid pace of spending growth has slowed somewhat, partly in response to the earlier increases in energy prices," they said.

Oil prices soared into record territory in March and hit a new peak of $57.27 a barrel at the beginning of April — straining household and business budgets. Prices have since retreated and now hover above $50 a barrel.

The Fed also drew fresh attention to rising prices in general.

"Pressures on inflation have picked up in recent months and pricing power is more evident," the statement said, a reference to businesses finding it easier to raise prices to customers. But it tempered that inflation warning with an assessment that longer-term inflation expectations remain "well contained." The Fed also said underlying inflation — which excludes energy and food prices — is "expected to be contained."

Against that backdrop, the Fed said it could continue on its path of gradually raising rates. In Fed parlance that is stated as "at a pace that is likely to be measured." To analysts, that phrase translates into quarter-point increases.

On Wall Street, there was little reaction. The Dow Jones industrials gained 5.25 points to close at 10,256.95.

Private analysts expect the Fed to boost rates by another quarter-point at its next meeting June 29-30 and probably through much of this year. That said, they also believe the Fed’s future rate decisions could become increasingly more dependent on how inflation and economic activity unfold.

"The Fed, while acknowledging the slowdown in the economy, is focused more on inflation. That means their work is not done," said Stuart Hoffman, chief economist at PNC Financial Services Group. "The Fed will become even more of a data hound and not quite as much on automatic pilot" when it comes to raising rates.

For economists and investors, that’s a subtle shift in their perceptions. At the Fed’s previous meeting, on March 22, policy-makers’ hawkish tone about inflation ignited speculation that the central bank might raise rates more aggressively — possibly by a bolder half-point — in the summer. That spooked Wall Street, sending stocks tumbling.

Since that meeting, however, the economy has flashed signs of slowing.

Over the first three months of the year, the economy grew at a 3.1 percent annual rate, the slowest in two years as energy prices restrained spending by individuals and companies. Some economists believe growth in the April-to-June period could be even less.

Employers added just 110,000 jobs in March, the fewest in eight months. April’s employment report comes out Friday, and economists predict it will show that 170,000 jobs were created.

Fed policy-makers, however, said labor market conditions "continue to improve gradually."

Inflation, meanwhile, is climbing. Driven by expensive gasoline and energy products, overall consumer prices jumped by 0.6 percent in March, the biggest increase since October.

Even more troubling to economists was the 0.4 percent rise in core inflation — a gauge that excludes energy and food prices. That was the largest increase in 2 1/2 years.

——

On the Net:

Federal Reserve: http://www.federalreserve.gov/

Associate Press

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