Fed lifts key rate, but is ambiguous

Tentative statement follows rise to 5%

May 11, 2006|By WILLIAM NEIKIRK | WILLIAM NEIKIRK,CHICAGO TRIBUNE

WASHINGTON -- After raising interest rates once again as expected, the Federal Reserve made one thing perfectly clear yesterday. It just might, or might not, be finished with its nearly two-year-old campaign to fight inflation with higher borrowing costs.

Both Wall Street and Main Street had been expecting the central bank to announce a pause in pushing up short-term borrowing costs. But all they got was a highly tentative statement from Chairman Ben S. Bernanke's Fed about its next move at the end of June. It could go either way.

It took only one word to convey the Fed's new uncertainty - "yet." The central bank said "some policy firming may yet be needed to address inflation risks" before it decides on a pause. Translated, that means more interest-rate increases might be coming, and soon.

Why? Increases in oil and other commodity prices, plus a building of inflationary pressures in other parts of the economy, have conspired to make the central bank nervous about announcing it will take a breather from raising interest rates just now.

Bernanke and his colleagues raised the federal funds rate by another quarter-percentage point to 5 percent yesterday. The rate is what banks charge each other for overnight borrowing. Any further interest rate decisions "will depend importantly on the evolution of the economic outlook as implied by incoming information," the Fed statement said.

Most observers of the central bank have said the Fed, which has raised the key rate 16 straight times, is close to its goal of achieving a "neutral" interest rate, one that keeps inflation in check without damaging economic growth.

To economists like John Silvia of Wachovia Securities in Charlotte, N.C., and Keith Hembre of FAF Advisors in Minneapolis, a mutual fund investment firm, the Fed finds itself in a bind, with inflation suddenly stirring, the housing market increasingly fragile and the economy's strength for the rest of the year still uncertain.

"I don't think they know what they are going to do," Silvia said. "It all depends on the data."

"The `yet' in the statement meant that they may have to do a little more tightening," Hembre said. "I think they are concerned with inflationary expectations accelerating. I think they are trying to buy themselves some time."

If the central bank does tighten the money supply and credit, it means that short-term interest rates - already 4 percentage points higher than they were in 2004 - may have to go up. That means Americans who have home-equity or other adjustable- rate loans will be paying more. Also, mortgage rates have been rising in recent weeks.

All other short-term rates are tied to the federal funds rate. For example, the prime lending rate went up to a five-year high of 8 percent after the announcement.

But much of the focus on the Fed's announcement was on what it would do in the future. In congressional testimony earlier this year, Bernanke had indicated that the central bank might pause from raising interest rates for one or two meetings, so that it could assess the economy's course and its next move.

David Wyss, chief economist at Standard & Poor's, a prominent credit-rating firm, said Bernanke's Fed is hoping that the red-hot economy will cool off in the second half of the year and help bring inflation under control without further interest-rate increases.

So far, Wyss said, the huge rise in oil and gasoline prices has yet to be built into the general inflation rate.

The Fed said it expects economic growth to slow this year. Inflationary expectations remain "contained," it said, but added that "possible increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures."

William Neikirk writes for the Chicago Tribune.

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