Fed raises interest rate, plays down inflation fears

Quarter-point increase is 10th consecutive rise

August 10, 2005|By Paul Adams | Paul Adams,SUN STAFF

The price of a barrel of crude hit a record high this week. Housing prices continue to soar. Health care and insurance costs are up by double digits. Food is getting more expensive. Utility prices are jumping. Tuition costs are out of control.

Sounds as if it might be time to dust off those circa 1974 "Whip Inflation Now" buttons that were once the laughingstock of the Ford administration, right?

Actually, the Federal Reserve says not to worry - at least for now. The Fed raised a key interest rate another quarter-point yesterday and indicated that its more-than-yearlong campaign to contain inflation can continue at an unhurried pace.

One reason is that American workers continue to produce more goods for not much more money, according to new data released by the Labor Department yesterday. That increases the likelihood that businesses can keep prices for goods - and thus inflation - in check.

The Fed's optimism about the effects of its continuing inflation vigil should be good news for nervous consumers, who have been expressing less confidence in recent weeks as news about oil prices have conjured images of gas lines and economic malaise. Despite years of relative economic strength, fear of the 1970s stagflation bogeyman has been woven into American culture every bit as much as the Vietnam War and Watergate.

Yesterday's economic news suggests "that at least through next spring, inflation pressures aren't that great," said Joel L. Naroff, chief economist at Naroff Economic Advisors, a consulting firm in Holland, Pa.

But economists say there are dangers ahead for consumers and the economy. Oil prices continue to be a wild card that, if not contained, could ultimately send prices for goods soaring.

Businesses also are continuing to hire more aggressively, which could force wages up and, again, lead to higher prices. And finally, interest rate increases - which the Fed said yesterday it would continue "at a pace that is measured" - could at long last send home mortgage rates up, potentially letting some air out of the housing bubble that has been fueling so much consumer spending of late.

"You can be pretty happy as a consumer right now, but I think the risks, though, are on the upside in terms of inflation accelerating and you can be pretty sure the Fed is going to raise rates at least two more times," said Steven G. Cochrane, a senior economist at Economy.com.

The Fed raised its target for the federal funds rate - the rate banks charge each other - a quarter-point to 3.5 percent, the 10th consecutive increase and the highest level in almost four years. The rate increases began in June 2004, when rates were at a 46-year low of 1 percent.

In making the announcement, the Fed indicated it would keep raising rates, but continue to do so in the quarter-point increments favored by jittery Wall Street investors. The Fed meets three more times this year, in September, November and December.

Speaking to reporters at his ranch in Crawford, Texas, President Bush declared the economy on strong footing and said he was not focused on the Fed's latest rate increase.

"I think we're more concerned about energy prices and health care prices," he said.

The economic news helped send the Dow Jones industrial average up 78.74 points to close at 10,615.67. Investors were also buoyed by falling oil prices after Monday's record high.

The Labor Department report said that gains in labor costs slowed in the second quarter to an annual pace of 1.3 percent, while worker productivity gained 2.2 percent in the second quarter, down from 3.2 percent in the first.

Productivity - worker output per hour - is critical to maintaining living standards. Higher productivity allows businesses to sell more goods without hiring more labor, leading to higher profits without raising prices.

If productivity slows too much, however, businesses have to make up for the decrease by hiring more workers and, most likely, passing the costs on to consumers. There are some signs that's happening. U.S. employers added 207,000 jobs last month, the most in three months.

"If productivity is falling, more labor has to be applied to meet demand," said Alan Levenson, chief economist for T. Rowe Price in Baltimore. But so far, he said, prices have accelerated moderately thanks to surging productivity in the years since the 2001 recession.

However, Cochrane, of Economy.com, said there is evidence some manufacturers have been able to raise prices of certain consumer goods without losing sales. He pointed to Proctor & Gamble, makers of shampoos and soaps, as an example.

"We see now that a number of companies have gained pricing power," he said.

On the wage side, the latest data suggest that increases are moderating after several months of strong gains. However, some sectors - particularly manufacturing - saw faster gains, which drove up unit labor costs. Those numbers will be watched closely by the Fed as it considers whether it is doing enough to keep inflation under control.

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