Fed boosts key interest rate to 4 percent
(AP)
Updated: 2005-11-02 10:33

WASHINGTON - The Federal Reserve raised interest rates on Tuesday to the highest level in more than four years and indicated that more increases were likely in an effort to keep a lid on inflation.

Outgoing Chairman Alan Greenspan and his colleagues voted unanimously to boost the rate banks charge each other by a quarter-point, to 4 percent. It was the 12th increase of that size since the Fed began tightening credit in June 2004.

In response, commercial banks began increasing their prime lending rate by a corresponding amount, to 7 percent. These rates are used for many short-term consumer loans, including certain credit cards and popular home equity lines of credit.

Wall Street shrugged — the Dow Jones industrials closed down 33.30 points.

"The cumulative rise in energy and other costs have the potential to add to inflation pressures," the Fed said in a brief statement after the meeting.

Fed policy-makers suggested that they are more concerned about the prospects of an inflation flare-up than the economy suffering a serious slowdown from the hurricanes that ravaged the Gulf Coast.

"Elevated energy prices and hurricane-related disruptions in economic activity have temporarily depressed" production and employment, the Fed said. But "planned rebuilding in the hurricane-affected areas" will likely help energize the economy going forward, it said.

"I think the Fed made pretty clear that Katrina and Rita won't have long-lasting negative consequences," said James Feyrer, economics professor at Dartmouth College.

Looking ahead, additional rate increases can proceed "at a pace that is likely to be measured," the Fed said. Analysts view this as meaning further quarter-point increases can be expected.

"The message is that they are not done. They still feel the threat of potential inflation is out there in the economy, and that means they have more work to do," said Stuart Hoffman, chief economist at PNC Financial Services Group.

With the Fed slowly making it more expensive to borrow, Americans' appetites for big-ticket goods likes cars and homes could be moderated so that overall economic activity can move ahead at a pace that won't aggravate inflation pressures.

Many economists are predicting the Fed will boost rates at its next session, on Dec. 13, as well as on Jan. 31, which will be Greenspan's last meeting. Some analysts also are calling for another rate increase on March 28, which would be the first presided over by Ben Bernanke, President Bush's choice to replace Greenspan.

Bernanke, a former Fed governor, is chairman of the White House's Council of Economic Advisers. His nomination is subject to Senate approval, which is expected.

Bernanke has said that his first priority will be to maintain continuity with Greenspan's policies. Fed watchers say that means inflation-fighting will keep playing a prominent role.

A rapid pickup in inflation, if not blunted by other economic forces, can erode workers' paychecks and drive up business costs. If inflation is bad enough, it can short-circuit economic growth.

Some economists believe the Fed's key rate could rise to 5 percent by the spring or early summer. That would put the prime rate at 8 percent and would likely prompt the Fed to take a break for a while.

High energy prices, worsened by hurricanes Katrina and Rita, have fanned inflation worries. Consumer prices soared by 1.2 percent in September, the biggest increase in a quarter-century. The main culprit is a 12 percent jump in energy prices.

Oil prices briefly shot up past $70 a barrel in late August, and gasoline prices topped $3 a gallon before moderating. But home heating costs are expected to be much higher this winter than a year ago.

So far, "core" consumer prices — which exclude food and energy — have behaved well. That indicates high energy expenses are not filtering into the costs of a wide variety of goods and services. In September, core prices, which are closely watched by the Fed, nudged up by just 0.1 percent.

Because core prices remain fairly tame, the Fed can stick with its gradual approach to raising rates, policy-makers said.