Fed boosts rates, hints at end to tightening

18 months of increases focused on inflation


The Federal Reserve boosted its benchmark short-term interest rate by a quarter percentage point to 4.25 percent yesterday but sparked hopes that it might be nearing an end to its 18-month credit-tightening program.

The central bank, in the statement accompanying its 13th consecutive rate increase, no longer described its policies as "accommodation." It has used that word to indicate that interest rates are low enough to encourage economic growth.

The removal of the word suggests that the Fed is closer to its target of a "neutral" rate level, one that neither stimulates nor stunts growth, analysts said.

The Fed also said, however, that "some further measured policy firming is likely to be needed," suggesting further quarter-point rate increases to combat inflation.

Some analysts immediately reaffirmed forecasts that the Fed's benchmark rate could rise as high as 4.75 percent next year, up from 1 percent in June 2004.

The increase in the Fed's benchmark federal funds rate, which banks charge each other for overnight loans, will lead to higher borrowing costs for consumers and businesses. Many banks raised their prime lending rates a quarter point to 7.25 percent yesterday, which will boost charges on some home equity loans, variable-rate credit cards and other borrowings whose rates are pegged to the prime.

Rates on certificates of deposit and other interest-paying vehicles will also rise, helping savers.

Other Fed statements yesterday said that "possible increases in resource utilization as well as elevated energy prices have the potential to add to inflation pressures."

Some analysts viewed that statement - which has not appeared in previous Fed pronouncements - as a signal that the central bank might raise rates even more aggressively than had been expected.

The use of the phrase "increases in resource utilization" - Fed language for a decline in the unemployment rate, which is near a four-year low at 5 percent - suggests that the Fed is concerned that a tightening labor market could push up wage costs, said Ian Shepherdson, chief U.S. economist for High Frequency Economics in Valhalla, N.Y.

"It signals that the labor market has now moved again to center stage in the Fed's analysis and policy making process," Shepherdson said.

Workers welcome higher wages, but Fed policymakers fear that rising pay could ignite inflationary expectations among businesses, making it easier for them to pass higher costs along to customers. Such expectations could be self-fulfilling, as was the case in the inflationary 1970s.

The economy is performing well with inflation under control, the Fed suggested.

"Despite elevated energy prices and hurricane-related disruptions, the expansion in economic activity appears solid. Core inflation [excluding food and energy] has stayed relatively low in recent months and longer-term inflation expectations remain contained," the central bank said.

Investors generally cheered the news, interpreting a possible end to rate increases as bullish for stock prices. Major Wall Street indexes rallied modestly, with the Dow Jones industrial average gaining 55.95 to close at 10823.72. Bond yields changed little.

The Fed statement was consistent with recent data showing the economy growing strongly amid robust business and consumer spending and a pickup in hiring in the months after Hurricanes Katrina and Rita.

Recent economic data also suggest that inflation remains in check, partly because of falling energy prices and robust gains in worker productivity. Also, the nation's five-year-old boom in housing prices has been slowing, which could reduce pressures on the Fed to try to push up mortgage rates.

Analysts suggested that the economy and interest rates are at a crossroads, increasing the risk if the Fed makes a misstep.

"The central bank runs the risk of raising the interest rate too fast. Historically, the central bank had overreacted to inflationary pressures, contributing to economic recessions," said Sung Won Sohn, an economist and chief executive of Los Angeles-based Hanmi Bank.

If the Fed stops raising rates too soon, however, inflation expectations could be heightened, Sohn said, which could push up mortgage rates and hurt the housing market.

The next Fed policy-making meeting, scheduled Jan. 31, will be the last official meeting for retiring Fed Chairman Alan Greenspan. Analysts expect further changes in the Fed's policy statement then, possibly to clear the slate for incoming Chairman Ben S. Bernanke.

Many analysts expect another rate increase at Bernanke's first policy-setting meeting, scheduled for March 28.

Bill Sing writes for the Los Angeles Times.

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