Fed jolts interest rates up

November 16, 1994|By John E. Woodruff | John E. Woodruff,Sun Staff Writer

The Federal Reserve gave short-term interest rates their biggest upward bump in 13 years yesterday, trying to head off inflation as government reports showed the U.S. economy is pushing its limits harder than it has in nearly 15 years.

Yesterday's move raised short-term rates by three-fourths of a percentage point. It was the sixth -- and the largest -- increase since the Fed set out Feb. 4 to get a grip on inflation by raising the cost of borrowing money.

Major banks responded immediately yesterday by raising their prime rates, which determine what millions of consumers pay on auto loans, credit card balances and home-equity loans, to 8.5 percent from 7.75 percent.

Economists immediately expressed doubts that even yesterday's increase will contain the inflationary pressures in the surging U.S. economy.

"Furniture sales, major appliances, automobiles, building supplies, all are still very strong," said Alfred G. Smith III, chief economist for NationsBank Corp. "And there are some 2 million more people working today than there were a year ago, so the likelihood is that the Fed will have to go on raising rates for some time."

The Fed had been widely expected to raise rates by just a half-point yesterday, but it went for the stronger medicine after the Commerce Department reported that the economy is still expanding faster than expected despite the five previous rounds of rate increases.

The Commerce reports showed that retail sales posted their fifth straight monthly advance in October, rising 1.1 percent, and that U.S. factories worked at 84.9 percent of capacity, up 0.7 percentage points from September. That's the busiest U.S. factories have been since President Jimmy Carter's last year, in February 1980.

Fed Chairman Alan Greenspan often points to capacity rates as one of the inflation indicators the central bank watches most closely -- and to 85 percent as the level that creates the bottlenecks that enable workers to demand higher wages and producers to charge higher prices.

"In these circumstances, the Federal Reserve views these actions as necessary to keep inflation contained and thereby to foster sustainable economic growth," the central bank said in announcing the increases, which it approved in a closed-door meeting of its Open Market Committee.

For millions of consumers and businesses, the Fed's decision will mean higher interest rates within the next 30 to 60 days. For millions of savers, it could signal eventual higher returns from savings accounts and certificates of deposit, but only after a lag of several months.

For Maryland's economy, still trailing far behind the national recovery, it is yet another blow.

"Maryland already is looking at a plan by the new [Republican] majority in Congress to cut some 1,900 congressional staff jobs, which means hundreds of highly paid Maryland professional people could be out of work by January," said Charles McMillion, president of MBG Information Services, a Washington-based consultancy that tracks the state's economy.

"The state's manufacturing sector is hobbled by defense cuts, so Maryland needs retail sales -- a good Christmas season -- more than most. Higher interest rates going into this Christmas season will just add to the headwinds the state faces," Mr. McMillion said.

The Fed's action was stronger than the half-point increase Wall Street had expected, and the Dow Jones industrial average reacted by going on a roller-coaster ride.

After spending much of the day about 20 points higher than Monday's close, the Dow plunged more than 40 points in less than 20 minutes after the Fed's announcement.

But long-term interest rates gradually eased after the announcement, a sign that bond investors were taking the Fed's moves as evidence that the central bank is serious about fighting inflation.

The lower long-term rates seemed to calm the jitters in the stock market. At day's end, the Dow was down a scant 3.37 points, at 3,826.36. The yield on the benchmark 30 1/4 -year Treasury bond was at 8.03 percent, down from 8.07 percent Monday.

Yesterday's moves put the federal funds rate, which banks pay each other for overnight loans, at 5.5 percent, and the discount rate, which the Fed charges when banks borrow directly from the central bank, to 4.75 percent. Both rates were at 3 percent at the beginning of this year.

By early next year, as the higher prime rate plays out into consumer credit rates, the monthly payment on a typical adjustable-rate $30,000 home-equity loan will be about $62.50 higher than it was before the Fed started raising rates last February. The payment on a typical adjustable $2,500 credit-card balance will be more than $5 a month higher than it was last February.

The Fed's determination to head off inflation has created an unlikely alliance of business leaders, labor unions and liberal Democratic politicians to oppose higher rates.

The AFL-CIO and several liberal organizations staged a demonstration against rising interest rates outside the Fed's headquarters as the Open Market Committee met yesterday, and union representatives joined the National Association of Manufacturers last week to warn against an increase as a threat to economic growth.

But the Fed is likely to raise interest rates at least a few more times before it is convinced that inflation is under control, most economists believe.

THE 6 INCREASES

Federal funds rate increases this year:

Feb. 4: 0.25 percentage point to 3.25 percent

March 22: 0.25 percentage point to 3.5 percent

April 18: 0.25 percentage point to 3.75 percent

May 17: 0.5 percentage point to 4.25 percent

Aug. 16: 0.5 percentage point to 4.75 percent

Nov. 15: 0.75 percentage point to 5.50 percent

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