- The Washington Times - Tuesday, April 18, 2006

Federal Reserve officials yesterday indicated that they are close to finishing a nearly two-year-long string of interest rate increases, sparking a strong rally in financial markets.

The Dow Jones Industrial Average soared by 195 points, the most in a year, after minutes of a Fed meeting in March were published in midafternoon. The minutes said the Fed thought it had nearly achieved its goal of heading off a bout of inflation after raising short-term rates by nearly four percentage points in 15 consecutive moves since June 2004.

“Most members thought that the end of the tightening process was likely to be near, and some expressed concerns about the dangers of tightening too much, given the lags in the effects of policy,” the minutes said, adding that the central bank is poised to resume its practice of raising rates only if economic reports show inflation pressures mounting.

Fed policy-makers noted during the meeting that inflation remains remarkably tame, despite increasingly tight labor and product markets and rapidly rising energy prices that led premium crude oil to close yesterday at $71.35, another record, on the New York Mercantile Exchange.

Janet Yellen, president of the Federal Reserve Bank of San Francisco, foreshadowed the momentous change by saying earlier yesterday that the federal funds rate, the Fed’s main tool for influencing bank rates, “is close to a neutral stance, one that neither stimulates the economy nor restrains it.”

“Although inflation is in the upper portion of my comfort zone, it appears to be well-contained at present, and my best guess for the future is that it will remain well-contained,” she told a California business group in remarks released by the Fed.

“Before I seem to make this picture too rosy-looking, I want to remind you that there are lot of uncertainties on both the upside and the downside,” she said, including the prospect that the slowdown in the housing market will be much deeper than expected.

“I will be highly alert to the possibility of the policy tightening going too far,” she said.

Economic reports released yesterday showed that wholesale inflation was tame in March despite a major jump in energy prices, while new home construction remained on a downtrend with another 7.8 percent fall in housing starts.

The Fed’s comments, especially those showing it is aware of the danger of raising rates too much, were welcome on Wall Street, where many economists and traders have grown anxious that the central bank would increase rates so much that it would end up hurting the economy in a zeal to head off inflation.

Wall Street’s major stock indexes, including the Standard & Poor’s 500, the Nasdaq Composite and the Russell 2000, posted gains ranging from 1.7 percent to 2.7 percent in the best rally the market has shown since April last year.

Many Fed watchers interpreted the statements as a sign that it will pause after raising the federal funds rate another quarter-point to 5 percent in May. With inflation running about 3 percent a year, that would leave rates at their historical level of about two percentage points above the inflation rate.

“The minutes reinforce our view that the [Federal Open Market Committee] will soon stop raising the fed funds rate, perhaps at its next meeting in May,” said Augustine Faucher of Economy.com.

The Fed’s commentary yesterday appeared designed to reverse the impression it gave the markets at the conclusion of the March meeting, the first headed by Chairman Ben S. Bernanke. A statement released at that time contained no significant change in wording from previous statements, telegraphing to the markets the mistaken impression that the Fed was nowhere near the end of its rate cycle. The markets fell on the news.

Some of the 12 members of the Federal Open Market Committee were worried that the markets would misunderstand, the minutes showed. But they went along with other members who thought any change in wording would create the impression that the Fed would stop raising rates altogether, despite its intention to keep raising rates if warranted by rising inflation pressures.

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