Fed nudges rates higher

Policy-makers act to cool economy, head off inflation Fourth 1/4-point increase Move was expected

stock market shows little response

February 03, 2000|By William Patalon III | William Patalon III,Sun Staff

Federal Reserve policy-makers, concerned that a shortage of workers and a scorching economy will touch off inflation, raised a key interest rate a quarter-point to 5.75 percent yesterday -- an action that was anticipated and that economists believe presages further rate increases to keep the record economic expansion humming.

"I think this is the right thing to do to prolong growth in an economic expansion that's now 107 months old," said Philip J. Schettewi, senior managing director of Newark, N.J.-based Prudential Global Asset Management, which oversees $100 billion.

Stocks hardly stirred: The Dow Jones industrial average dropped 37.85 points to close at 11,003.20, while the Nasdaq composite index climbed 21.98 points to end the day at 4,073.96.

The sizzling U.S. economy -- which set a record Tuesday for the longest expansion in U.S. history -- shows no signs of slowing. If anything, it's been accelerating.

The composite index of U.S. leading economic indicators -- a closely watched forecast of business conditions -- rose 0.4 percent in December, after increasing 0.3 percent in November and 0.1 percent in October, the Conference Board reported yesterday.

That beat analysts' estimates and ranked as the largest gain since January 1999. The steepening upturn in the indicators suggests growth will remain strong -- at least through the first half of this year, economists said.

Housing, too, remains hot. Sales of new homes rose more than expected in December, reversing a decline in November and capping a record 12 months for the industry, the Commerce Department said yesterday.

The year ended with sales of 904,000 new homes, topping the previous record of 886,000 in 1998 and underscoring that stock market wealth, job growth and rising incomes have been trumping rising mortgage rates.

Consumers -- who account for more than two-thirds of economic output and who have been fueling the boom with record spending -- will likely feel a pinch as rates for mortgages and car loans rise. Bank of America, the biggest U.S. bank, and others said they will raise their prime lending rates from 8.5 to 8.75 percent today in response to the Fed's action.

The increase in that benchmark lending rate will filter through the banking system, making for higher loan rates for consumers and businesses. But, with consumer confidence at its highest-ever level, market watchers believe it's going to take more than a single quarter-point increase to temper the consumer buying binge.

Unfortunately, with many companies already running at full capacity, to boost output to meet this insatiable demand, they need to hire more workers. And those workers aren't available in the marketplace, which forces firms to pirate workers from other firms, often through hefty raises. Such bidding wars can run up a firm's employment costs -- its biggest expense -- which is highly inflationary.

The central bank's policy-setting Federal Open Market Committee acknowledged all these concerns in the statement announcing its decision to increase the federal funds rate.

"The committee remains concerned that over time increases in demand will continue to exceed the growth in potential supply," the FOMC said. "Such trends could foster inflationary imbalances that would undermine the economy's record economic expansion."

That comment illustrates why many economists predict the Fed will raise interest rates again at either -- or both -- of its next meetings: March 21 and May 16.

"It looks as if the markets are going to suffer the torture of a thousand cuts as the Fed continues to firm policy and maintain its credibility as an inflation-fighter in the months ahead," said Vincent Boberski, senior economist with the Minneapolis-based Dain Rauscher Inc.

The Fed essentially made two moves yesterday. First, it raised the fed funds rate -- the rate that banks charge each other for overnight loans -- by the quarter-point.

And, in a related action, the central bank's Board of Governors approved a quarter-point increase in the discount rate to 5.25 per

cent. The more symbolic discount rate is what banks pay on money borrowed directly from the Fed to meet their reserve requirements.

Usually the fed funds and discount rates are kept within a half-point of each other.

Before yesterday, the Fed had raised interest rates three times since June -- on June 30, Aug. 24 and Nov. 16 -- essentially taking back three rate drops enacted in

1998 to keep the U.S. economy, as well as economies overseas, from feeling an even deeper bite from the so-called "Asian contagion."

The rate cuts succeeded in staving off trouble, but ultimately helped spur even stronger growth here at home: U.S. Gross Domestic Product, the measure of all goods and services produced in the United States, grew at a 5.8 percent annual rate in the fourth

quarter of 1999, an acceleration from the 5.7 percent pace recorded for the third quarter.

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