Inflation concerns push up interest rates

Wednesday, March 23, 2005

WASHINGTON -- When it comes to the Federal Reserve, what it says is as important as what it does.

Economists, investors and everyone else paying attention pretty much knew the Fed was going to boost rates by a quarter-point Tuesday, the seventh such increase since its credit tightening campaign began last June.

What they really wanted to know was the Fed's thoughts on the economy and inflation. The assessment they got: Inflation is picking up -- a seemingly obvious statement that still managed to surprise economists and rattle investors.

The Dow Jones industrials fell 94.88 points to close at 10,470.51.

Fed policy-makers "are saying they are a bit worried about inflation. ... People should get used to the idea that interest rates will keep going up," said Stuart Hoffman, chief economist at PNC Financial Services Group.

Federal Reserve chairman Alan Greenspan and his colleagues, concerned that soaring energy prices could stoke broader inflation, boosted the federal funds rate to 2.75 percent and signaled rates would continue to head higher in the months ahead.

In a brief statement after their meeting, the Fed policy-makers drew more attention to rising prices than they have in previous assessments, noting that "pressures on inflation have picked up in recent months."

Still, they said the increases in energy prices haven't fed through to "core" consumer prices -- those for a variety of goods other than food and energy. And, they said, "longer-term inflation expectations remain well contained."

Economists viewed the Fed's overall comments on inflation as slightly more hawkish than previous statements and believed that suggested further interest-rate increases well into the year.

"The central bank has more work to do to combat possible inflation in the future," said Sung Won Sohn, president and chief economist of Hanmi Bank.

In response to the Fed's action, commercial banks began lifting their prime lending rates by one-quarter point, to 5.75 percent. This rate, used for many short-term consumer and business loans, moves in lockstep with the funds rate.

Energy prices climb

The Fed is lifting rates as energy prices are climbing again. Oil prices, which set a new record high last week, were hovering above $56 a barrel in trading Tuesday. That's helping to propel gasoline prices sharply higher.

More expensive energy and food were the culprits behind wholesale prices rising 0.4 percent in February, the most in three months, the government reported Tuesday. However, "core" prices -- which exclude energy and food -- inched up 0.1 percent.

For now, the Fed decided to keep language it has used with every rate increase, saying that future rate increases would occur "at a pace that is likely to be measured." Measured has come be to viewed as quarter-point bumps.

A few economists thought that language might be dropped at Tuesday's meeting. Some believe it might be dropped at a subsequent meeting, perhaps at the next Fed gathering May 3 or the meeting on June 29 and 30.

If the "measured" phrase is abandoned, that could mean future interest-rate increases might be less predictable than they have been, economists said. But even if that happens, some economists don't believe it necessarily means the Fed will begin to order bolder, half-point rate increases.

How economic activity and inflation unfold in the months ahead, however, will ultimately shape how the Fed acts.

"The Fed is saying we have a lot more work to do," said Ethan Harris, chief U.S. economist for Lehman Brothers.

Some economists predict the Fed will keep lifting the funds rate through much of this year, pushing the rate up to around 4 percent. That would put the prime rate at 7 percent.

The funds rate is the interest that banks charge each other on overnight loans and is the Fed's main tool for influencing the economy. Before the Fed began its rate-raising campaign, the funds rate stood at 1 percent, a 46-year low.

That extraordinarily low rate had been used to shore up the economy, which had struggled to recover from the 2001 recession and the Sept. 11, 2001, terrorist attacks.

These days the economic expansion is firmly rooted.

The economy, which grew at a solid 3.8 percent annual rate in the final quarter of 2004, is expected to do as well or better in the current quarter, analysts predict.

Fed policy-makers said the economy "continues to grow at a solid pace despite the rise in energy prices and labor market conditions continue to improve gradually."

Employers added 262,000 jobs in February, the most since October. Economists are hopeful payrolls will post sizable gains in the coming months, though they are concerned that may not occur if energy prices continue to surge and make businesses more cautious.

Even with the Fed's string of rate increases, longer-term rates, such as mortgage rates, have behaved relatively well. Economists expect longer-term rates will rise gradually -- rather than shoot up -- in the months ahead.

Some analysts predict rates on 30-year mortgages will climb by the end of the year to a high of around 6.5 percent, which would still be considered fairly low by historic standards. Rates on 30-year mortgages now stand at 5.95 percent.

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