Fed pushes rates higher, anticipating stronger economy

WASHINGTON -- The Federal Reserve, discounting recent signs of economic weakness, pushed ahead Tuesday with its campaign to keep inflation under control by boosting a key interest rate by a quarter-point.

Wall Street, encouraged by the Fed's optimistic assessment of economic prospects, pushed stocks higher.

Declaring that the economy "appears poised to resume a stronger pace of expansion," Federal Reserve chairman Alan Greenspan and his colleagues announced they were increasing the target for the federal funds rate from 1.25 percent to 1.50 percent.

Commercial banks immediately followed that move by announcing they were raising their prime rates, the benchmark for millions of business and consumer loans, from 4.25 percent to 4.5 percent. The prime rate normally moves in lockstep with Fed rate increases.

Many economists read the Fed's statement as a signal that the central bank intended to keep pushing rates up by quarter-point moves at each of its remaining three meetings this year.

"This is a very confident statement. They are unequivocal in their view that the economy is going to revive," said Mark Zandi, chief economist at Economy.com.

Investor confidence was bolstered by the Fed's assurances that the recent slowdown should be temporary, and stocks moved sharply higher. The Dow Jones industrial average finished the day up 130.01 points at 9,944.67.

President Bush, who is seeking to avoid his father's fate of being one-term president because of a weak economy, is insisting the economy has turned the corner, but a slump in various economic statistics in recent weeks has cast doubts about that contention.

Fewer new jobsThe government reported last Friday that only 32,000 jobs were created in July, the poorest showing this year and far below the 200,000-plus jobs analysts had been expecting.

After that weak report, many analysts believed the Fed would go ahead with an expected quarter-point rate increase this week but might signal that it was prepared to pause in September if the economy had not shown signs of a rebound by then.

The Fed statement Tuesday did note that economic growth had moderated and the improvement in the labor market "has slowed." But it blamed the slowdown on the spike in energy prices, and said it should be short-lived.

The boost in the funds rate marked the second quarter-point move this year following a June 30 increase which had been the Fed's first rate increase in four years. Like its June statement, the Fed again said it believed it could raise rates "at a pace that is likely to be measured."

Economists have interpreted that as meaning quarter-point moves at regular intervals of Fed meetings. Many saw its repetition in the August announcement as a sign that the central bank sees no need to alter its plan for steady but modest rate increases in coming months.

Analysts noted that even with a half-point increase in the funds rate so far, this key Fed policy lever remains at a level that, before last year's cut, was last reached in the early 1960s.

Not putting the brakes on

"The Fed is not putting the brakes on the economy," said Bill Cheney, chief economist at MFC Global Investment Management in Boston. "They are just getting their foot off the accelerator."

Economist David Jones, author of several books on the Greenspan Fed, said he still believed the Fed could put its credit tightening on hold, at least for September, if the August jobs report, due out Sept. 3, does not show sharp improvement.

"The fact that they acknowledged the softness in the economy injects a note of caution in the Fed's actions," Jones said. "I think they are going to be very measured and cautious going forward."

The central bank pushed the funds rate to a 46-year low of 1 percent in June 2003, the 13th in a series of rate cuts that began in January 2001 as the Fed battled to right the economy after a series of blows including the country's first recession in a decade, the Sept. 11, 2001, terrorist attacks and a wave of corporate accounting scandals.

In Tuesday's statement, the Fed said it believed an economic revival was being supported by interest rates that were "accommodative" and by "robust underlying growth in productivity."

Earlier Tuesday, the government reported that productivity in April-June quarter rose at an annual rate of 2.9 percent, the smallest gain since late 2002, but still significantly higher than the anemic productivity increases posted during the 1970s and 1980s.

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