Fed raises rates

Offering no letup in its fight against inflation, the Federal Reserve on Tuesday raised its benchmark short-term rate by a quarter-point for the 10th consecutive time and indicated that more hikes would be coming.

The central bank's widely expected boost in its federal funds target rate, to a four-year high of 3.5%, renewed a debate about whether the Fed might become irrationally exuberant in its anti-inflation crusade.

Some investors and analysts contend that the central bank is overestimating the threat of inflation and could ultimately raise rates too high, slowing the economy unnecessarily. The Fed's last cycle of credit tightening in 2000 led to a recession the year after, they say.

But the Fed on Tuesday indicated that it would have none of that soft-on-inflation talk. In its statement accompanying the rate announcement, the central bank's Open Market Committee once again said it would continue to raise rates at a "measured" pace — Fed-speak for more quarter-point boosts, Los Angeles Times reports.

The Fed also acknowledged what recent economic data have made clear: Growth has gained momentum in recent months without a significant pickup in inflation.

"Aggregate spending, despite high energy prices, appears to have strengthened since last winter," the Fed statement said. It added that although "core inflation has been relatively low in recent months … pressures on inflation have stayed elevated."

Analysts viewed the statement as further confirmation that the Fed wouldn't quit tightening credit anytime soon. Many are now betting that the Fed will push its short-term target rate as high as 5%. Two months ago, the smart money thought 4% might be tops. The rate was 1% in June 2004.

"It is very hard to draw any conclusion other than that rates have some way further to rise," said Ian Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, N.Y.

Major banks immediately raised their prime lending rates by a quarter of a point to 6.5%. That will in turn elevate costs for variable-rate credit cards and some other consumer and business loans.

Yields on long-term bonds — which have risen sharply in the last month on expectations of faster economic growth — fell slightly Tuesday as traders were encouraged by the Fed's benign comments on current inflation.

Stock investors' reaction also was muted, with major indexes closing up for the day but near their levels when the Fed issued its statement less than two hours before the market close.

"It has taken nearly four years to do the round trip and get rates back to 3Ѕ per cent," Mickey Levy, chief US economist at Bank of America was quoted as saying by Financial Times. "The bottom line is that they still see policy as accommodative and expect to continue raising rates at a measured pace. They gave every indication that they will continue to raise rates and that it is the strength of the economy that will lead them to do it."

While the Fed has raised the fed funds rate by 150 basis points since June last year, the yield on the 10-year note, in spite of a rise in recent weeks, remains 40 basis points below the level when the Fed embarked on the tightening campaign.

The still low level of long-term rates is likely to bolster the committee's intention to continue raising the fed funds rate. Policymakers have highlighted froth in the housing market, encouraged by low long-term rates, and the knock-on effect on consumer spending, Financial Times reports.

Futures markets have priced in a fed funds rate of about 4.1 per cent by the end of the year, which suggests expectations that the committee will raise rates again in September and November and uncertainty about whether there will be another rate increase in December. Many economists expect the Fed to continue raising rates next year, while some have raised the possibility of a larger 50 basis point rate if the committee decides that inflation risks demand a more aggressive approach.

Alan Greenspan, Fed chairman, has said unit labour costs are the key to assessing the core inflation outlook.

Over the past 12 months unit labour costs were up 4.3 per cent, but Fed policymakers are confident some of that reflects one-off bonus and stock-based compensation payments.