Feb 2006 Financial News

Fed hikes rates again as Greenspan wraps term

Feb 01, 2006

Federal Reserve Chairman Alan Greenspan wrapped up an eventful 18-year career Tuesday with a final interest rate hike and cleared the way for his successor Ben Bernanke to bring the long credit-tightening campaign to a close.

Acting on Greenspan’s final day in office, Fed policy-makers raised the benchmark overnight lending rate another quarter-percentage point to 4.5 percent, pushing up borrowing costs for consumers and businesses in their ongoing bid to keep a lid on growth and inflation.

Minutes after the Fed's announcement, the Senate ratified President Bush's nomination of Bernanke, 52, a former Fed governor and Princeton University professor, who is expected to be sworn in Wednesday. Bernanke, who had strong bipartisan support and whose appointment has been well-received on Wall Street, was approved on a voice vote.

It was the 14th consecutive time, dating to June 2004, that the Greenspan-led Federal Open Market Committee met and voted to raise rates a quarter-point. The Fed's decisions on rates ripple throughout the banking system. Commercial banks, for example, were expected to quickly boost their prime lending rate, the basis for many home-equity loans and other credit products, a quarter-point to 7.5 percent.

In what some analysts saw as a nod to the incoming Fed chief, the central bank also shifted its policy statement, noting that "recent economic data have been uneven" and saying only that further rate hikes "may be needed." The comment signals the possibility that the Fed panel could put rates on hold when Bernanke chairs his first meeting March 28.

Previously the Fed had clearly signaled further rate hikes ahead, saying "some further measured policy firming is likely to be needed."

"It makes sense they would make it a little more open, just because the next meeting is still pretty far away, and when you have a new guy coming in you want to give him as much wiggle room as possible," said Jan Hatzius, chief U.S. economist at Goldman Sachs.

Financial markets showed little reaction to the shift in policy, with broad stock market falling in late trading after the announcement to close with a modest loss.

Most Wall Street economists assume Bernanke will have to engineer at least one more rate hike even if only to establish his credentials as an inflation fighter, but for the first time in nearly two years, there is no longer a de facto guarantee that the Fed will move at its next meeting.

Bernanke steps into his new role at a time of transition, as the Fed has pushed up the benchmark federal funds rate from a 46-year low of 1 percent in mid-2004 and the economy appears to be slowing a bit.

And although Bernanke's background is mainly academic, the monetary policy expert also has served nearly three years as a Fed governor and probably will not hesitate to put the Fed on the sidelines, especially if there is more evidence of economic weakness over the next two months.

Friday’s report that the nation’s gross domestic product grew at a sluggish 1.1 percent rate in the fourth quarter probably in itself will not be enough to convince Bernanke and his colleagues to stop raising rates, economists said.

"Like most economists, we view the fourth-quarter number as a bit of a fluke," said Ethan Harris, chief U.S. economist at Lehman Bros. Most of the weakness, especially in consumer spending, appeared to be concentrated in the early part of the quarter, when Hurricane Katrina and other storms dampened spending in parts of the country.

"More forward-looking indicators are pointing to a solid first quarter," Harris said..

He and other analysts also expect employment growth to bounce back when the latest monthly numbers are reported Friday after relatively weak figures for December.

At the same time quarterly data closely watched by Fed policy-makers showed consumer inflation rising to 1.9 percent, a bit higher than the central bank’s presumed comfort zone, analysts said. That suggests the Fed will indeed have to push rates higher.

"The Fed will remain on alert for higher inflation until the economy slows up on a sustained basis," said Harris. "They can't just cross their fingers and hope inflation doesn't pop up. There is also a case for the new Fed chairman, if it’s a close call, to prove his anti-inflation credentials and do a little hike or two."

Still, with nearly two months between meetings, another rate hike is not a sure bet.

"The autopilot phase of monetary adjustment is behind us, and future rate moves will depend on the data," said Neal Soss, head of U.S. economics for Credit Suisse, in a research note.

At 79, Greenspan is stepping down at the expiration of his term as governor after winning widespread acclaim for steering the economy through many global crisis while keeping inflation low and economic growth generally strong. His 18-1/2-year tenure included a 10-year expansion from 1991 to 2001 that was the longest of the postwar era and two recessions, including the relatively mild downturn of 2001.

Greenspan, a former business consultant and Republican economic adviser, originally was nominated by President Reagan and took office in August 1987. He established his reputation just two months later when he managed to keep financial markets operating through the devastating stock market collapse that began Oct. 19, 1987.

He was renominated by Presidents Bush, Clinton and Bush and by the end of his term had gained nearly mythical status, respected by political leaders on both sides of the aisle in Washington.

Despite intense media interest, Greenspan kept a low profile right until the very end of his tenure, at least in part to ensure a smooth transition. In a modest nod to the significance of the moment, the Fed allowed photographers and a video camera into the Fed board room at the conclusion of Tuesday's meeting.

Greenspan will have plenty of opportunity to speak out afterward, with plans for a new consulting business, an active calendar of speaking engagements and a book.

Martin Wolk
Chief economics correspondent
MSNBC
Updated: 7:39 p.m. ET Jan. 31, 2006
http://www.msnbc.msn.com/id/11104282/