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Fed raises rates to 3 and half as measured plan Original Source Link: (May no longer be active)
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Fed Raises Funds Rate to 3.25%, Keeps `Measured' Plan (Update2)
June 30 (Bloomberg) -- Federal Reserve policy makers raised the benchmark U.S. interest rate a quarter point to 3.25 percent and restated a plan to carry out further increases at a ``measured'' pace.
``Monetary policy remains accommodative,'' the Federal Open Market Committee said today in a statement after a two-day meeting in Washington. ``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.''
Retaining the ``measured'' language suggests the FOMC is concerned that low long-term interest rates outside its direct control are still stoking the economy, prompting central bankers to keep raising their overnight bank lending rate to head off faster inflation. Today's rate increase, the ninth straight, brought the Fed's target to the highest since June 2001.
``As far as the Fed is concerned, it's still on track to raise interest rates again,'' said former Fed Governor Lyle Gramley, now a senior adviser at the Stanford Washington Research Group in Washington. ``It suggests that the economy is still doing quite well, and that further increases in short-term rates lie ahead of us.''
One phrase that changed in today's statement said that inflation concerns are still high. ``Pressures on inflation have stayed elevated, but longer term inflation expectations remain well contained,'' the statement said. The statement from the May 3 meeting had said that pricing power was ``more evident'' and that pressure had ``picked up in recent months.''
Market Reaction
Today's wording is ``a little bit more inflammatory from a semantic standpoint than their prior statements,'' said Diane Swonk, chief economist at Mesirow Financial Inc. in Chicago. ``I wouldn't be surprised if it was intended to add a little more uncertainty to the bond market. I think the Fed is trying to send a signal that they think rates should be higher, whether it's bond yields or short-term rates.''
Investors instead pushed bond yields down, comforted by the prospect that the Fed has inflation under control. The benchmark 10-year Treasury note rose 3/16 point, pushing its yield down 2 basis points to 3.95 percent at 2:46 p.m. in New York.
All 22 of Wall Street's biggest bond trading firms, the so- called primary dealers in government debt that trade directly with the Fed, predicted an increase to 3.25 percent, according to a Bloomberg News survey. Eighteen predict the Fed will raise its target rate to at least 3.75 percent by year-end. Today's vote to raise the target rate was unanimous.
Forecasts
The statement shows ``the Fed isn't finished and will continue to tighten,'' said Sage Advisory Services Ltd. co-founder Mark MacQueen in Austin, Texas. Sage Advisory manages $3.8 billion. `This has taken away the belief some market participants may have had that the Fed was about finished.''
Any major changes to the Fed statement, such as dropping ``measured,'' may wait until after Chairman Alan Greenspan presents the FOMC's semi-annual forecast to Congress on July 20, giving him a way to foreshadow the change before the next Fed meeting, economists said.
FOMC members probably tried to reach a consensus during their two-day meeting about what the low level of long-term rates means for monetary policy, economists said. Yields on U.S. 10-year notes have fallen from 4.69 percent in the past year, even as the central bank raised the overnight bank lending rate by a total now of 2.25 percentage points.
`Conundrum'
Greenspan, who is 79 and whose term as a governor expires in January, has called the situation a ``conundrum'' that is ``without recent precedent.'' Economists including Chris Rupkey at Bank of Tokyo-Mitsubishi in New York say the Fed's increased openness under Greenspan may have contributed to lower bond yields by removing risks that the FOMC would surprise investors.
Today's statement reinforces that the FOMC takes a different view than some investors and economists about what the low yields signify for the economy.
David Rosenberg of Merrill Lynch & Co. in New York is among the economists who interpret the low yields as a signal of slowing growth worldwide that will force the Fed to stop raising rates. Bill Gross, chief investment officer and manager of the world's largest bond fund at Pacific Investment Management Co., said June 21 that an overnight rate of 3.5 percent ``is as much as the Fed can risk'' and that by the beginning of 2006 the central bank may begin reducing rates.
Views Differ
Yet Fed officials in recent speeches expressed less concern about a potential slowdown than about so-called imbalances such as a record current account deficit, soaring home prices and low U.S. savings. Greenspan cited ``froth'' in the housing market on May 20. On June 15, Governor Donald Kohn said he was concerned about ``unusual imbalances.''
Today's statement reinforced that the FOMC sees strength in the world's largest economy. ``Although energy prices have risen further, the expansion remains firm and labor market conditions continue to improve gradually,'' today's statement said. Growth in productivity and monetary policy are both ``providing ongoing support to economic activity.''
The U.S. economy expanded at a 3.8 percent annual rate from January through March, an eighth straight quarter of growth exceeding 3 percent, a Commerce Department report showed yesterday. The economy expanded by 3.7 percent since the first quarter of 2004, the fastest among the Group of Seven industrialized nations. Low interest rates supported business investment spending and consumer purchases.
Economic Growth
``The phenomenon of historically low long-term rates is unfolding under dramatically different circumstances in the U.S., and, say, Europe,'' Anthony Karydakis, chief U.S. economist at J.P. Morgan Fleming Asset Management in New York, said before the meeting. ``In Europe, the phenomenon can be more readily explained on grounds of dismally weak growth, while in the U.S. growth has been quite robust.''
With today's action, the U.S. policy rate is 1.25 percentage points above the European Central Bank's refinancing rate, 0.75 percentage points higher than the Bank of Canada's overnight rate, and 1.5 percentage points below the Bank of England's base lending rate.
The U.S. continues to grow even as oil prices reach records, while inflation remains tame. Crude oil for August delivery reached $60.95 a barrel on June 27, the highest since the New York Mercantile Exchange began trading the contract in 1983; the price was about $57 a barrel earlier today.
Inflation
The Commerce Department said today its price gauge tied to spending patterns and excluding food and energy costs, Fed policy makers' preferred measure for tracking inflation, rose 0.2 percent last month and was up 1.6 percent from May 2004. The central bank earlier this year projected the price index would rise 1 percent to 2 percent this year.
Not all of the economic data has been strong. Orders for durable goods excluding transportation equipment declined in three of the past four months. Retail sales fell 0.5 percent in May and employers added 78,000 jobs in the same month, less than half what economists expected.
The Commerce Department today said personal spending stalled in May after rising in each of the prior three months, while incomes rose 0.2 percent after a 0.6 percent gain in April that was the biggest this year.
Even so, robust housing price increases may be buoying consumer confidence, which rose to the highest level in three years in June, according to the New York-based Conference Board. Low mortgage rates, which are usually linked to the yields on 10- year Treasury notes, have fueled the surge.
Home Prices
The average rate on a 30-year mortgage fell to 5.53 percent from 6.25 percent over the past 12 months. Average U.S. home prices rose 12.5 percent from the first quarter of 2004 to the first quarter of 2005, according to an index tracked by the Office of Federal Housing Enterprise Oversight. Twenty-four states showed average home price gains ranging from 10 percent to 31 percent during the period.
``What may be quite critical here with these lower long-term rates than we ordinarily expect, is it potentially engendering inflationary forces?'' Greenspan told the Joint Economic Committee of Congress on June 9. ``That's something which, needless to say, we are focusing on very extensively.''
Last Updated: June 30, 2005 14:56 EDT
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