Fed signals it's ready to tighten

Bias is adopted toward higher borrowing costs

`No need to panic'

Short-term interest rates are left unchanged

Central bank

May 19, 1999|By BLOOMBERG NEWS

WASHINGTON -- Federal Reserve Board policy-makers signaled yesterday that they are prepared to raise U.S. interest rates if economic growth does not slow and inflation accelerates -- even as they left the overnight bank loan rate unchanged at 4.75 percent.

The Federal Open Market Committee (FOMC) announced that it adopted a bias toward higher borrowing costs, saying it is "concerned about the potential for a buildup of inflationary imbalances that could undermine the favorable performance of the economy."

While the announcement comes only days after the government reported consumer prices rose in April by the largest amount in nine years, it does not guarantee that the Fed will raise the overnight loan rate any time soon. In September, for example, the financial shock waves from Russia's default on its debt caused the Fed to reverse its policy stance toward higher rates. The central bank ended up cutting the overnight rate that month for the first of what turned out to be three quarter-point reductions.

"There's no need to panic," said Greg Jones, chief economist at Briefing.com in Jackson, Wyo. "This is the 15th tightening bias since July 1996, and only once have they actually tightened. Until we see something on inflation, it's not going to happen."

The FOMC said "domestic financial markets have recovered and foreign economic prospects have improved" since the Fed's three interest-rate cuts last year.

"Against the background of already tight domestic labor markets and ongoing strength in demand in excess of productivity gains, the committee recognizes the need to be alert to developments over coming months that might indicate that financial conditions may no longer be consistent with containing inflation," the statement said.

That is a warning from the Fed that the risks have changed, said Diane Swonk, deputy chief economist at Bank One Corp. in Chicago. "We had a tremendous impact on the U.S. economy from Asia," she said. "Today's Fed action suggests they think that's passed, or at least that the worst is over."

The Dow Jones industrial average fell as much as 112 points in the minutes after the Fed announcement, erasing an earlier 77-point gain, and later closed at 10,836.95, down 16.52.

Fed Chairman Alan Greenspan foreshadowed yesterday's action when he warned in a May 6 speech that a runaway stock market and a generation-low unemployment rate threatened to derail the economy. "There are imbalances in our expansion that, unless redressed, will bring this long run of strong growth and low inflation to a close," he said.

The FOMC's aim is to keep the economy, now in its ninth year of expansion, from growing too fast and triggering higher consumer prices. Recent increases in yields on Treasury securities, mortgage rates and other borrowing costs for businesses and consumers might be slowing the economy from its 4.5 percent annual growth rate in the first quarter.

Yesterday's Fed announcement followed a Labor Department report Friday that showed the Consumer Price Index rose a larger-than-expected 0.7 percent in April. Outside of food and energy, the core rate of the CPI also posted a larger-than-expected increase, suggesting that inflationary pressures may finally be building.

"We have inflation ticking up," said Gary Thayer, chief economist at A. G. Edwards & Sons in St. Louis. "It's appropriate to adopt a tightening bias. I'd be worried about the Fed's credibility if they didn't."

Others are not convinced that April's jump in the CPI necessarily means consumer prices are about to surge. "One month isn't a trend," when it comes to last month's surge in the CPI, said Scott Brown, an economist at Raymond James & Associates in St. Petersburg, Fla.

Also yesterday, the full Federal Reserve Board left unchanged at 4.50 percent its more symbolic discount rate on loans to banks by the Fed system. And the Fed refrained from altering reserve requirements for banks.

Pub Date: 5/19/99

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