- The Washington Times - Tuesday, August 9, 2005

The Federal Reserve yesterday raised short-term interest rates to the highest level in nearly four years, citing “elevated” inflation pressures and aggressive spending by consumers.

The move came as a report showed labor costs — the chief ingredient of inflation — at the highest levels since 2000. Markets rallied on relief that the Fed did not take more vigorous action.

The central bank’s 10th quarter-point boost in rates in more than a year brought its target for the federal funds rate — the rate banks charge each other for overnight loans — to 3.5 percent.

Banks quickly followed suit, raising the prime lending rate to 6.5 percent — also the highest since September 2001. The prime rate is used to determine the rates on many home equity loans, adjustable-rate mortgages, credit cards and small-business loans.

Although the Fed’s move and the tenor of the statement issued by its rate-setting committee were less hawkish than some on Wall Street expected, the Fed made it clear it will keep raising rates every six weeks by a quarter-point until rates are at a level where it thinks they no longer are stimulating the economy.

“The Fed gave no hint that we are near the end of rate increases,” said Lynn Reaser, chief economist at Banc of America Capital Management Inc.

The Fed has raised interest rates at every one of its committee meetings going back to June 2004, when the funds rate stood at a 46-year low of 1 percent.

If the Fed keeps raising rates through the end of the year, as many analysts expect, it will have more than quadrupled the funds rate.

President Bush, without commenting directly on the Fed’s actions, endorsed “the judgment of Chairman Alan Greenspan” at a meeting with economic policy aides at his Texas ranch yesterday. He also cited high energy costs as the biggest concern overshadowing an otherwise healthy economy.

A wide range of economic reports has indicated that the economy is growing at a solid pace, the Fed said, despite a surge in oil prices to record levels near $64 a barrel on Monday.

Analysts say the Fed’s actions will keep mortgage and consumer loan rates moving up in the months ahead at a gradual pace that should only modestly slow the booming housing market.

Economists forecast an increase in the 30-year mortgage from 5.82 percent now to 6.25 percent by the end of the year.

Although some analysts had thought the Fed might stop raising interest rates so rapidly this year, that view changed after the economy showed new vigor and wage gains accelerated in recent weeks.

“Incoming data signal that strong growth has arrived, but recently quiescent inflation has yet to rebound,” said Richard Berner, chief economist at Morgan Stanley. “We expect that real growth will run at a hearty 4 percent pace in the second half of 2005 … and that inflation will move beyond the upper end of the Fed’s comfort zone.”

Yesterday, a report from the Labor Department showed that labor costs have risen 4.3 percent in the past year, the highest in five years, while worker productivity increases have slowed to 2.2 percent.

Most of the increase occurred at the beginning of the year as a result of one-time commissions, bonuses, stock options and other wage supplements earned or cashed in at that time.

Since then, labor costs slowed to a more modest 1.3 percent pace in the second quarter.

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