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Central bank seeks to keep inflation in check

Thursday, February 3, 2005

WASHINGTON -- The Federal Reserve pushed short-term interest rates higher Wednesday, part of a campaign begun last June and expected to continue well into this year to keep inflation and the economy on an even keel.

Fed chairman Alan Greenspan and his colleagues raised the target for the federal funds rate by one-quarter of a percentage point, to 2.50 percent. It was the sixth such increase since last summer. The rate is the interest that banks charge each other and is the Fed's main lever for influencing economic activity.

In a brief statement released after the Fed's two-day meeting, policy-makers stuck to their gradual approach of raising interest rates. Further increases can be "at a pace that is likely to be measured," according to the statement, similar to one issued at the previous meeting in December.

Economists said there was nothing in the statement to suggest that policy-makers will either speed up or slow down their rate-raising campaign.

The Fed said the economy is growing "at a moderate pace despite the rise in energy prices, and labor market conditions continue to improve gradually." Inflation, the Fed said, remains "well contained."

On Wall Street, the Fed's action helped boost stocks. The Dow Jones industrials gained 44.85 points to close at 10,596.79.

In response to the Fed's action, Wells Fargo also lifted its prime lending rate by one-quarter of a percentage point, to 5.50 percent. This rate, used for many short-term consumer and business loans, moves in lockstep with the funds rate.

Other commercial banks followed suit.

"Borrowing costs are still low relative to historic norms," said Greg McBride, a financial analyst with Bankrate.com, an online financial service. "But people have feasted on debt and the Fed will continue to raise rates. So the next six rate increases will be more significant to borrowers than the first six."

Economists predict the Fed will raise the funds rate again at its next meeting, in March.

Some economists believe the Fed wants continue to push up the funds rate to about 3.50 percent this year. Others think the fund rate will end up around 4 percent. Either figure, analysts said, would neither slow nor stimulate economic activity.

Moving the funds rate to 3.50 percent this year would push the prime rate up to 6.50 percent; a funds rate of 4 percent would put the prime rate at 7 percent.

Before the Fed started to push rates up in June, the funds rate was at a 46-year low of 1 percent.

That extraordinarily low rate was used to help shore up the economy, which had struggled to recover from the recession of 2001 and the Sept. 11 attacks. With the economic expansion more deeply rooted, the Fed needs to move the funds rate to a more normal level so all the cheap money does not lay the groundwork for inflation.

"If they don't act now and wait until prices are not well behaved, it may be too late," Chan said. "So, they are moving rates up gradually to minimize" the risk of inflation in the future, he said.

Even with the Fed's string of rate increases, longer-term interest rates, such as mortgage rates, have behaved well, in part reflecting investors' confidence that the Fed is managing inflation. Rates on 30-year mortgages fell last week to 5.66 percent, declining for a fourth straight week.

For all 2004, consumer prices rose 3.3 percent, the most since 2000. Much of that reflected surging energy prices. Even with the increase, analysts said prices still are considered relatively low by historical standards.

The economy finished 2004 with its best performance in five years despite slowing in the final stretch. Economic growth showed a 4.4 percent increase for all of last year, aided by brisk consumer and business spending.

Looking ahead, economists predicts the economy will grow by 3.5 percent or more in 2005. That would be sufficient to spur modest job growth in the months ahead, analysts said. The nation's payrolls in 2004 expanded by 2.2 million, the first annual increase in three years.


On the Net:

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


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