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Fed raises interest on inflation risk Original Source Link: (May no longer be active)
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Fed Raises Rate to 2.75%, Signals More Inflation Risk (Update3)
March 22 (Bloomberg) -- Federal Reserve policy makers, raising their benchmark interest rate another quarter point, said pricing pressures have increased. Stocks and bonds fell on concern the central bank is laying the groundwork to accelerate the pace of increases.
``Pressures on inflation have picked up in recent months and pricing power is more evident,'' the Federal Open Market Committee said in a statement released after the meeting in Washington. ``The rise in energy prices, however, has not notably fed through to core consumer prices.''
The stronger language on inflation risks came as the Fed raised its benchmark rate to 2.75 percent and restated a plan to carry out further increases at a ``measured'' pace. The policy makers have now raised the rate seven times since June, the longest streak in more than 25 years.
``The committee is stuck with a 25-basis-point rate increase for May, but this signals that more aggressive action, possibly a 50-basis point rise, is possible for June,'' former Fed Governor Lyle Gramley, now an adviser for the Stanford Washington Research Group in Washington, said in an interview. ``What this statement shows to me is that there is a division within the committee. There are some who are beginning to worry about the inflation problem. There are others who aren't convinced yet.''
The benchmark U.S. Treasury note fell 5/8 point after the decision, pushing the yield up 8 basis points to 4.60 percent at 3 p.m. in New York. The Standard & Poor's 500 Stock Index fell 4, or 0.3 percent.
Price Increases Build
Since the last Fed meeting on Feb. 1-2, crude oil prices surged to an unprecedented $57.60 a barrel, gasoline costs reached a record, and the Reuters-CRB index of 17 commodities surged to a 24-year high March 16 as copper prices rose to the highest since 1989. The Fed's so-called beige book regional survey said more manufacturers were able to pass on cost increases to customers, though with only limited effect on consumer prices.
Consumer prices excluding food and energy probably failed to accelerate in February, the Labor Department's report tomorrow is forecast to show. The core consumer price index probably rose 0.2 percent for a fifth month, according to the median estimate in a Bloomberg survey.
``They are setting us up for the possibility that they may need to accelerate if they think that the pace of inflation is picking up,'' said Edgar Peters, chief investment officer at PanAgora Asset management Inc. in Boston.
Gramley said the statement contained another significant change, one that shows that FOMC members know they must continue to act to keep inflation under control.
Forecast
``The committee perceives that, with appropriate monetary action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal,'' the statement said. In the previous meeting's statement, the language was less conditional.
The FOMC said today monetary policy ``remains accommodative'' and that with ``underlying inflation expected to be contained, the committee believes that policy accommodation can be removed at a pace that is likely to be measured.''
The rate increase was forecast by 100 of 105 economists surveyed by Bloomberg. The other five predicted the Fed would hold the rate steady.
``Look at what they said: Inflation pressures picked up, pricing power is evident,'' said Mark Spindel, chief investment officer at International Finance Corp., the investment arm of the World Bank, after the announcement. ``You need inflation protection, now more than ever.''
Greenspan
The Fed is trying to steer the overnight bank lending rate to a level that will keep the world's largest economy growing without speeding inflation. Some Fed officials including St. Louis Fed President Bank President William Poole have said the neutral range is between 3 percent and 5 percent.
Investors were expecting the Fed to raise the rate a quarter point at each of the next three meetings, according to fed funds futures contracts. The Fed's target rate is still less than overall consumer price inflation, meaning the real interest rate is negative.
Chairman Alan Greenspan has testified before four Congressional committees and one presidential panel since the last FOMC meeting. He did not use the word ``measured'' when referring to future interest rate increases, and some economists took that as a sign the FOMC planned to drop the language from this week's statement.
`Measured Pace'
When asked at a Feb. 16 Senate Banking Committee hearing about whether the Fed may soon scrap the wording, Greenspan said that even though inflation is contained, ``We're not going to have the same statement in perpetuity. At some point it's going to change.''
A Bloomberg News survey of the 22 bond firms that trade government debt directly with the Federal Reserve Bank of New York showed that 13 expected measured to be dropped by June, including three who expected it might go as early as today.
The FOMC, in its semi-annual economic forecast released last month, said the economy will grow as much as 4 percent from the final three months of 2004 through the fourth quarter of this year. Inflation, as measured by the Commerce Department's personal consumption expenditures index excluding food and energy, will increase 1.5 percent to 1.75 percent this year, according to the forecast.
U.S. wholesale prices rose 0.4 percent in February after rising 0.3 percent in January, the Commerce Department said today. The prices were boosted by higher costs for gasoline and food. Excluding good and energy, the index rise 0.1 percent.
Energy and Commodities
Crude oil prices are 54 percent higher than a year ago and the price reached a record $57.60 a barrel on March 17 in New York Mercantile Exchange futures trading. Gasoline futures rose to a record yesterday in New York on speculation that an Energy Department report tomorrow will show inventories fell last week.
Other commodity prices have also risen. Copper jumped 39 percent last year, and reached a record March 16 on expectations of stronger demand. Food prices rose 0.8 percent after a 0.2 percent decline a month earlier, the Labor Department said.
``From the Fed's perspective rising energy prices pose a dilemma,'' said Bruce Kasman, head of economic research at J.P. Morgan Securities Inc. in New York. ``At the same time that rising prices put upward pressure on inflation, they squeeze incomes and place a drag on growth.''
The Fed's survey of regional economic conditions showed that more manufacturers were able to pass on cost increases to customers. Still, those prices don't appear to be passing through to consumer prices, the Fed's beige book survey said. The core PCE index rose 1.6 percent for the year ended January.
Companies
Rohm & Haas Co., the world's biggest producer of acrylics used in paints and plastics, said last week that it will increase prices as much as 20 percent for automotive coatings in North American because of rising costs.
Caterpillar Inc., the world's largest maker of mining and earthmoving equipment, will raise prices in the next few months for the second time this year.
U.S. employers added 262,000 workers in February, the most since October, and the unemployment rate, determined by a separate survey of households, rose to 5.4 percent from a three-year low of 5.2 percent in January.
The stretch of seven increases is the most in more than 25 years, when a run of 20 ended with the rate at 15.5 percent in October 1979. The overnight bank-lending rate is the highest since September 2001, when the Fed lowered the rate 50 basis points five days after the terrorist attacks in New York and Washington.
Market Rates
Even so, the 1.75 percentage point increase since June has had little effect on market interest rates that determine what consumers pay on loans or earn from savings. For example, the average rate on a benchmark 30-year fixed mortgage last week was 5.91 percent, compared with 6.21 percent in late June, according to the Mortgage Bankers Association.
Bond investors, confident the Fed has inflation under control, also have kept yields low on government debt. The yield on the benchmark 10-year Treasury note was 4.49 percent at 11:45 this morning, after peaking at 4.87 percent in June.
Greenspan told lawmakers that the behavior of long-term interest rates during the tightening cycle is a ``conundrum.''
With today's action, the U.S. policy rate is 0.75 percentage points above the European Central Bank's refinancing rate, 0.25 percentage points higher than the Bank of Canada's overnight rate, and 2 percentage points below the Bank of England's base lending rate.
The U.S. central bank also raised the discount rate on direct loans to commercial banks to 3.75 percent today.
Last Updated: March 22, 2005 15:30 EST
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