Federal Reserve officials raised a key short-term interest rate yesterday for the fifth time this year and indicated they will gradually move rates higher next year to contain...
WASHINGTON Federal Reserve officials raised a key short-term interest rate yesterday for the fifth time this year and indicated they will gradually move rates higher next year to contain inflation as the economy continues to expand.
The policy-makers decided unanimously to raise the federal-funds rate, the interest rate charged between banks on overnight loans, to 2.25 percent from 2 percent. That leaves it 1.25 percentage points higher than when the Fed started raising rates in June, after holding the rate for a year at 1 percent the lowest level since 1958.
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In its statement after its meeting, the Fed’s top policy-making committee again said it would likely raise the funds rate at a “measured” pace in the future. Analysts have interpreted the phrase to mean increases in small steps by a quarter- or half-percentage point at a time spread out over many months.
Over the past six months, the Fed raised the rate by a quarter-point at each of its five scheduled meetings. Analysts widely expect that pace to slow in the coming year.
For example, the Bond Market Association said Monday its advisory panel of economists expects to see the funds rate rise to 3.5 percent by this time next year. That would mean raising the benchmark rate in 2005 by as much as it was raised in the past six months.
But the Fed’s language deliberately leaves flexibility to raise rates more aggressively if inflationary pressures flare, or to move more slowly if the expansion turns sluggish.
The Fed’s next scheduled meeting is in early February, giving officials a relatively long seven weeks to assess how the economy is doing.
The fed-funds rate influences other borrowing costs throughout the economy. Banks responded quickly by raising the prime rate charged on loans to their best business customers by a similar quarter point, to 5.25 percent. Many consumer rates tied to the prime, such as on credit cards and home-equity loans, might rise.
Longer term rates are determined by financial markets, reflecting the overall demand for credit and inflation expectations. With that demand still mild and inflation tame, many of those rates remain relatively low.
Mortgage rates, for example, fell last week to levels below those of a year ago. The average rate on a 30-year fixed rate mortgage slid to 5.71 percent; a year ago it was 6.02 percent.
Stock prices were little changed yesterday as the Fed’s move had been expected.
The markets’ calm is among the Fed’s biggest achievements in its rate-raising campaign. Policy-makers have worked very deliberately for more than a year to better communicate their thinking and likely actions to prepare the markets. In doing so, they have avoided any hint of the kind of financial turmoil that had accompanied past periods of rate increases.
In 1994 and 1995, for example, the central bank lifted its overnight rate much more aggressively than investors expected, to 6 percent from 3 percent in just 12 months, contributing to the Mexican peso crisis, the failure of investment bank Kidder Peabody and the Orange County, Calif., bankruptcy, according to many analysts.
But this year, Fed officials used a variety of communications the statements issued by its policy-making committee after every meeting, Fed Chairman Alan Greenspan’s frequent appearances on Capitol Hill and speeches by individual policy-makers to signal when and how they would start raising the funds rate.
“They did an excellent job of managing the transition,” said Robert DiClemente, chief U.S. economist for Citigroup.
Fed officials said in their statement the funds rate “remains accommodative,” which means it is low enough to stimulate the economy by encouraging businesses and consumers to borrow and spend.
Several Fed officials, including Greenspan, have talked this year about moving the rate over time toward a neutral level, at which it would neither stimulate nor slow growth, as the economy gains strength and approaches a point where the expansion no longer needs an extra push.
But Fed officials disagree about where a “neutral” rate would lie, offering estimates between 3.5 and 5.5 percent. They agree the rate depends on many variables, including federal spending, inflation and the growth of productivity or output per hour of labor.
Some officials, including Vice Chairman Roger Ferguson and San Francisco Fed Bank President Janet Yellen, have said wherever “neutral” is in the long term, it may be lower in the nearer term because of several drags on economic growth, including high energy costs and slow hiring.
Other risks to growth include the very low personal-savings rate and the fading effects of last year’s tax cuts, which gave people more cash to spend. These concerns would appear to argue for a less aggressive course of rate increases in the coming year.
These and others have indicated that while they want to move the funds rate toward neutral, they want to keep it below that level long enough to spur more improvement in the job market.