Fed applies brakes with a fifth rate rise

Overnight-loan cost to banks increases quarter-point to 6%

`The Fed isn't kidding'

Action to slow down expansion will raise what consumers pay

Monetary policy

March 22, 2000|By William Patalon III | William Patalon III,SUN STAFF

Federal Reserve policy-makers, concerned that continued consumer exuberance will ultimately fuel inflation, raised short-term interest rates a quarter point yesterday -- the fifth such rate increase since June.

In boosting the overnight lending rate to 6 percent -- a move that Fed-watchers almost unanimously expected -- the central bank's policy-setting Federal Open Market Committee has one objective: rein in an economy that continues to thunder, thanks to record consumer confidence, plentiful jobs and the wealth generated by the long bull market for stocks and a healthy market for housing.

The FOMC also increased the more symbolic discount rate a quarter-point to 5.5 percent yesterday.

Stocks soared in an expression of relief by investors, who had been fearful that the Fed might resort to a half-point boost. The Dow Jones industrial average zoomed 227.10 points, or 2.13 percent, to close at 10,907.34, and the Nasdaq composite index gained 101.68, or 2.21 percent, to 4,711.68.

The broader Standard & Poor's 500 index climbed an even steeper 2.56 percent, rising 37.24 points to end the trading day at a record: 1,493.87. That surpassed its Dec. 31 closing high, and wiped out a year-to-date loss.

"The Fed isn't kidding, and they are going to slow the economy down, so investors are returning to classic blue-chip, highly liquid stocks," said Thomas Madden, chief investment officer for stocks at Federated Investors Inc. in Pittsburgh.

Consumers and corporations planning to borrow money for big-ticket purchases will feel the pinch from yesterday's move by the Fed.

Bank of America Corp., the biggest U.S. bank, Chase Manhattan Corp. and other major banks raised their prime lending rate a quarter-point to 9 percent, and many other lenders are expected to follow within days. That will translate into higher rates on loans for such things as cars, houses and production equipment, and will nudge payments up for adjustable mortgages.

The Fed, headed by Chairman Alan Greenspan, said it was still concerned that demand for products and services is so high that companies may not be able to meet it, leading to shortages that will drive prices skyward while setting inflation in motion. And once inflation takes hold, it can take years to eradicate.

"Increases in demand will continue to exceed the growth in potential supply, which could foster inflationary imbalances that would undermine the economy's record expansion," the Greenspan-led FOMC said in its statement.

Most economists figure the central bank will increase interest rates again this year -- perhaps several more times -- in the hope that the roaring U.S. economy will decelerate a bit. Last month, the U.S. economy set a record for the longest uninterrupted stretch of growth in the nation's history, eclipsing the 106-month run of the 1960s.

"Expect further rate hikes," said Richard Yamarone, chief economist for Argus Research in New York City.

Yamarone thinks the Fed will raise short-term rates a quarter-point each May 16 and June 28, after which he predicts that the central bank "goes on hold."

Gerald D. Cohen, senior economist for Merrill Lynch & Co. in New York City, sees a rate increase in May, and then "possibly in June or August."

How many times -- and how much -- interest rates have to go up depends a lot on consumers, who continue to spend like every day is a red-tag sale. Retailers such as Wal-Mart Stores Inc. and Target Corp. said same-store sales in February were up 6.1 percent and 5.6 percent, respectively -- hefty increases that show why Fed members are worried about red-hot demand in the economy.

Even so, the central bank must avoid being too aggressive, economists warn.

For one thing, it takes from six to 18 months for an interest-rate increase to work its way through the economic system, though some economists argue that the real impact is not first seen until about nine months have passed. If that is true, then the full effects of the first increase -- announced June 30 -- are only now visible, said Merrill Lynch's Cohen.

The Fed subsequently raised the overnight lending rate, also known as the federal funds rate, Aug. 24, Nov. 16, Feb. 2 and yesterday. The overnight lending rate is what banks with excess reserves charge other banks that need an overnight loan in order to meet reserve requirements.

So far, the most visible impact of tighter credit has been on the housing sector, where there has been visible slowing. But car and truck sales are on pace to top last year's record of nearly 17 million vehicles sold.

And gross domestic product -- the sum of all goods and services produced domestically -- surged at a 6.9 percent annual clip in the closing quarter of 1999 after rising 5.7 percent in the third quarter.

Worse still, the U.S. trade deficit widened to a record $28 billion in January, as oil prices spiraled higher and imports of automobiles and other products soared -- showing a continued propensity to spend, the Commerce Department reported yesterday.

Rising incomes have helped propel spending. But so has the stock market, which, despite recent pullbacks, has run up a long way in recent years, boosting personal savings and making consumers more confident to buy expensive SUVs or trade-up housing.

With the stock market, Greenspan faces a true quandary: He says the market is too high and that stocks are overpriced; and yet, he does not want to raise rates to the point of forcing a big drop, or even a crash -- souring the economy, and disrupting or even ending an economic expansion that entered its 108th month at the beginning of this month.

"I worry about it, sometimes," said Merrill Lynch's Cohen. "But I believe the Fed's on the right track," and is moving slowly enough to make sure it doesn't end the U.S. boom.

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