The Federal Reserve also signaled that more rate hikes were likely even as the country recovers from the devastating effects of Hurricane Katrina.
WASHINGTON – The Federal Reserve today boosted a key interest rate for the 11th straight time and signaled that more rate hikes were likely even as the country recovers from the devastating effects of Hurricane Katrina.
The action pushed the Fed’s target for the federal funds rate — the interest that banks charge each other— to 3.75 percent. That’s the highest level since the summer of 2001.
Some economists had believed that Katrina, the country’s costliest natural disaster, might prompt the Fed to pause temporarily in its campaign to drive interest rates higher to keep inflation in check. But Federal Reserve Chairman Alan Greenspan and his colleagues said that Katrina’s impact on the overall economy was likely to be short-lived.
In a brief statement explaining the action, the Fed said that all the problems from Katrina “will be a setback in the near term” for the economy. But the Fed said it did not believe that Katrina would pose a “more persistent threat” and therefore believed it needed to continue raising interest rates to guard against inflation.
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The Fed’s rate increase spurred commercial banks to raise their prime rate by a quarter-point. That pushed the prime, the benchmark for millions of consumer and business loans, to 6.75 percent, its highest point in more than four years. The increases were led by Wells Fargo and KeyCorp.
The Fed indicated it was more concerned that inflation pressures could intensify from the spike in energy prices that has occurred this year, including a surge after Katrina shut down production along the Gulf Coast.
“Higher energy and other costs have the potential to add to inflation pressures,” the central bank said in its statement.
“The reason they didn’t pause at this meeting was the concern about higher energy costs,” said David Jones, head of DMJ Advisors, a Denver economic consulting firm.
Ian Shepherdson, chief U.S. economist at High Frequency Economics, said that he expected the Fed to keep raising rates in quarter-point moves at its final two meetings of the year on Nov. 1 and Dec. 13.
“The Fed has not been deflected from its prior course by Hurricane Katrina,” he said. “Softer data for the next few months are likely, but they will have to be awful to persuade Alan Greenspan to pause.”
Investors were not happy with the Fed’s decision. The Dow Jones industrial average lost ground after the mid-afternoon announcement.
Fed Governor Mark Olson cast a lone dissenting vote, with the Fed explaining that he preferred to leave rates unchanged at today’s meeting. The action was approved on a 9-1 vote of the Federal Open Market Committee, the panel of Fed governors and regional Fed bank presidents who meet eight times a year to set interest rates.
The federal funds rate stood at a 46-year low of 1 percent when the Fed began raising interest rates in June 2003. Since that time, it has boosted rates at all of its regularly scheduled meetings.
The central bank signaled in its statement that more rate hikes could be expected by retaining language it has used in the past to describe the current level of interest rates as “accommodative.”
Fed policy-makers also kept language stating that they believed rates could be raised “at a pace that is likely to be measured.” That language is viewed as signaling further gradual quarter-point rate hikes.
The Fed, while deciding not to take a pause in its rate hikes because of Katrina, spent a good deal of its statement discussing the hurricane’s likely impact.
“The widespread devastation in the Gulf region, the associated dislocation of economic activity and the boost to energy prices imply that spending, production and employment will be set back in the near term,” it said.
But Fed policy-makers concluded, “While these unfortunate developments have increased uncertainty about near-term economic performance, it is the committee’s view that they do not pause a more persistent threat.”
The Fed’s goal is to push the funds rate up to a level where it is neither stimulating economic activity nor slowing it down. Many economists believe that level lies somewhere between 4 percent and 4.5 percent.
The Fed had pushed the funds rate down to 1 percent as it battled to overcome the negative impacts of the bursting of the stock market bubble in 2000, the 2001 recession and the terrorist attacks that year. However, with the economy now growing at a solid rate, the desire is to make sure that interest rates do not stimulate economic activity to such an extent that unwanted inflation pressures are triggered.
Many analysts believe that Greenspan wants to have completed the credit tightening needed to get to a neutral rate before he leaves office at the end of January.