Federal Reserve raises rate a quarter-point as expected

Central bank signals plan for more small increases

August 11, 2004|By William Neikirk | William Neikirk,CHICAGO TRIBUNE

WASHINGTON - The Federal Reserve stood its ground yesterday and raised interest rates modestly for the second time this summer, despite signs of a weaker job market and slower economic growth.

The central bank coupled its interest-rate increase with a sunny outlook, saying the economy is poised to shake off its sluggishness and resume "a stronger pace of expansion going forward," reassuring words that helped boost the stock market.

Wall Street responded with enthusiasm. The Dow Jones industrial average rose 130.01 points to close at 9,944.67.

But analysts said the market will need more positive economic news in coming weeks to reverse its recent slide.

The central bank did not rule out another interest rate increase in September and, in fact, said its monetary policy, even with higher interest rates, is still "accommodative" - that is, enough to keep the economy rolling.

Unless the economy weakens significantly, said Mickey Levy, chief economist at the Bank of America, the Fed is likely to raise interest rates again at its next meeting Sept. 21, the last one before the Nov. 2 presidential election.

Several other analysts agreed.

The 0.25 percentage point increases that the Fed appears to have in mind are designed to bring extremely low interest rates up to a more normal level over time and to prevent prices from rising out of control.

The "measured" pace of the increases is calculated to get interest rates back up without harming the economy.

Two straight months of weak job growth and a "soft patch" in economic conditions had caused many analysts to wonder whether Chairman Alan Greenspan's Fed would take a break from its strategy of steadily increasing interest rates over the next year.

The Fed's policy-making arm, the Federal Open Market Committee, answered with a firm no.

First, it raised its benchmark short-term interest rate by one-quarter of 1 percent, the same increase as in June, and then served notice that it would continue to boost interest rates at a "measured" pace over the longer haul.

The decision put the so-called federal funds rate, the rate at which banks borrow from each other, at 1.5 percent. This rate influences short-term rates across the economy, including the prime lending rate.

Oil prices blamed

The Fed blamed the recent "soft patch" in the economy chiefly on a "substantial rise in energy prices" and implied that it expected that oil prices would not continue to increase in the immediate future.

Most economic analysts had expected the increase, but many added that they were surprised the Fed is sticking with its "measured" plan for a series of interest rate increases amid new evidence that the economy had begun to slow.

David Resler, chief economist at Nomura Securities International, said the Fed's statement was "a lot more upbeat than I would have expected would be the case" in view of recent downbeat economic statistics. But he added that he agrees with the central bank that the economy will get stronger.

Even with a modest increase in interest rates, the Fed said, "the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity."

Agreeing with the decision was Brian Wesbury, chief economist at the Chicago investment banking firm of Griffin, Kubik, Stephens & Thompson Inc. He said holding the Fed's benchmark rate below the rate of inflation for an extended period would be a "recipe for stagflation [a stagnant economy with high inflation] and disaster."

"They didn't back off," said Bill Zadrozny, chief executive at Siemens Financial Services, commenting on reports that the central bank might soften its monetary stance.

Opposing view

But Peter Morici, business professor at the University of Maryland, disagreed sharply with the central bank, saying monetary policy is not as accommodative to economic growth as it appears.

Rising energy prices are not the only drag on the economy, he said. Others include an end to the fiscal stimulus provided by lower tax rates, a trade deficit that drains away jobs to other countries and a weak stock market, he said.

"Unemployment above 6 percent in 2005 is becoming a genuine risk," he said. It was 5.5 percent in July.

In today's economy, Morici said, the United States needs much lower interest rates to grow over the long run.

Another bearish statement came from Peter Schiff, president of Euro Pacific Capital, a California investment firm, who claimed the U.S. economy is beset with many deep problems, including heavy consumer debt, a housing market "bubble" and too many heavily indebted corporations.

Recession inevitable

He said a deep recession is inevitable, and the Fed should bring it on more quickly to "purge all the mistakes of the boom."

But most economic analysts had more moderate comments. Cynthia Latta, principal U.S. economist at Global Insight, a consulting firm, said she expected that the nation's chief monetary authority would revamp its statement slightly to take note of this summer's "soft patch."

"I guess they are a little hesitant to suggest things might be falling apart," she said.

Latta predicted the economy will grow by 3.9 percent in the second half of the year, less than the strong 5 percent the central bank has forecast, and 2005 looks like a solid year, too.

The Chicago Tribune is a Tribune Publishing newspaper.

Baltimore Sun Articles
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.