Sep 2005 Financial News

Fed Boosts Rates, Downplays Katrina Fears

Sep 21, 2005

WASHINGTON (AP) -- The Federal Reserve boosted interest rates to the highest level in four years Tuesday despite the effects of Hurricane Katrina, saying fallout from the storm didn't pose a "persistent threat" to the nation's economic health.

The Fed made clear that fighting inflation remained its No. 1 job.

Taking no break in a 15-month rate-raising campaign, as some had speculated, Fed Chairman Alan Greenspan and his colleagues opted to raise an important short-term interest rate by one-quarter percentage point to 3.75 percent. It marked the 11th increase of that size since the Fed began to tighten credit in June 2004.

In response, commercial banks began raising their prime lending rates by a corresponding amount, to 6.75 percent. These rates are used for many short-term consumer loans, including some credit cards and popular home equity lines of credit.

The increases pushed borrowing costs to their highest level since the summer of 2001.

On Wall Street, stocks fell. The Dow Jones industrials lost 76.11 points to close at 10,481.52.

Fed policymakers held the door open to additional rate increases in the months ahead -- depending on how economic activity and inflation unfold.

Much of the Fed's brief statement -- issued after its closed-door meeting -- was devoted to looking at the economic impact of Katrina, which slammed the Gulf Coast in late August, knocking out essential oil facilities and destroying businesses, homes and lives.

High energy prices made worse by the storm "imply that spending, production and employment will be set back in the near term," Fed policymakers said. Disruptions to oil and gas supplies may add to energy price gyrations, they said.

Policymakers struck a hopeful tone that such economic fallout would not be long lasting.

"While these unfortunate developments have increased uncertainty about near-term economic performance, it is the (Fed's) view that they do not pose a more persistent threat," policymakers concluded.

Fed policymakers observed that before Katrina struck, the economy was moving ahead at a "good pace. Economists said the Fed was trying to convey the sense that because the economy was in such good shape it should be able to weather reasonably well the jolt from the storm.

Analysts said the economy is resilient and is expected to bounce back.

For now, Katrina is expected to reduce overall economic growth in the second half of this year by as much as 1 percentage point as high energy prices crimp consumer and business spending, vital ingredients for healthy economic activity.

Hiring is expected to slow. A reduction of 400,000 jobs over the next four months is forecast.

In sticking to their rate-raising course, though, Fed policymakers suggested that the risk that high energy prices could touch off broader inflation was greater than the threat of slower economic activity.

"Higher energy and other costs have the potential to add to inflation pressures," Fed policymakers said.

Oil prices on Monday shot up more than $4 a barrel -- the biggest one-day price jump ever -- amid worries that a new storm could further hobble oil production facilities on the Gulf Coast. Prices calmed down on Tuesday.

President Bush-- coping with sinking approval ratings -- wants Congress to approve a massive reconstruction program for the Gulf Coast. The federal government's costs could reach $200 billion or more. Congress already has approved $62 billion.

Rebuilding, once under way, should help energize overall economic activity and the jobs climate, though probably not until next year. All the billions of dollars expected to be pumped into the economy, however, are raising heightened fears about inflation, analysts said.

"Clearly the Fed's main eye is on inflation," said Stuart Hoffman, chief economist at PNC Financial Services Group. "They are more worried about inflation because they view the setback to economic growth as temporary."

The Fed said it would maintain a course of "measured" rate increases in the months ahead. Economists have come to view that as quarter-point bumps.

Analysts had mixed opinions, though, on whether the Fed will raise rates at both of its next two scheduled meetings this year -- on Nov. 1 and Dec. 13. Many believe that the Fed's key short-term rate, now at 3.75 percent, will be rising. Some think it could climb to 4.25 percent or 4.50 percent by the spring of next year.

The sole dissenter to the Fed's decision to boost rates on Tuesday was Fed Governor Mark Olson. He favored leaving rates unchanged.

Leading up to the Fed's meeting, there was speculation that policymakers might take a temporary break in their rate-raising campaign.

"The central bank won't back off" until it's convinced that inflation isn't a threat to the economy, said economist Sung Won Sohn, president of Hanmi Bank.

Jeannine Aversa, AP Economics Writer
Yahoo Finance
Tuesday, 20th September, 2005
http://biz.yahoo.com/ap/050920/fed_interest_rates.html?.v=21