- The Washington Times - Thursday, June 30, 2005

The Federal Reserve, keeping a watchful eye on the impact of surging oil prices, raised a key interest rate by another quarter-point yesterday.

The action pushed the federal funds rate up to 3.25 percent. It marked the ninth increase in the interest that banks charge each other on overnight loans and left this benchmark rate at its highest level since September 2001. When the Fed started its credit-tightening campaign a year ago, the funds rate had been at a 46-year low of 1 percent.

In announcing the decision, the Fed maintained a pledge it has been making for the past year to move rates up “at a pace that is likely to be measured,” a phrase that has been read by financial markets as signaling continued quarter-point moves in the future.

The decision by Federal Reserve Chairman Alan Greenspan and his colleagues came as the economy is growing at a solid pace even though it is being buffeted by rising oil prices, which earlier this week reached a record high above $60 per barrel.

The Fed’s statement said even with the rise in energy prices, the economy has continued to grow at a respectable pace.

“Although energy prices have risen further, the expansion remains firm and labor market conditions continue to improve gradually,” the Fed said.

The government reported Wednesday that the overall economy grew at a healthy rate of 3.8 percent in the first three months of this year and many analysts believe growth in the current quarter will be only slightly slower than that pace.

The Fed said that pressures on inflation “have stayed elevated” but repeated a belief it has made in past statements that “longer-term inflation expectations remain well contained.”

That phrase is seen as a signal that the Fed feels no need to accelerate its rate increases.

While consumer prices had risen sharply in March and April, they declined for the first time in 10 months in May, reflecting a big plunge in energy prices.

The continued good performance of inflation, outside of energy, has allowed the Fed to nudge rates higher in small steps. The Fed’s goal is to push the funds rate up to a neutral level where it is neither stimulating the economy nor holding back business growth.

Many economists believe that strategy calls for a funds level of around 4.25 percent, which could be reached by the end of the year if the Fed keeps boosting rates by a quarter-point at its August, September, November and December meetings.

However, some analysts believe the Fed will pause at some point, possibly after the August increase, to assess how the rate increases are affecting the economy.

The Fed’s short-term rate increases normally produce an increase in long-term rates, which are set by financial markets. However, that hasn’t occurred during this cycle of increases. Treasury’s benchmark 10-year bond was at 4.8 percent a year ago and now is around 4 percent.

The decline in long-term rates has kept mortgage rates at historic lows this year and has been a major contributor in the surging housing market. Sales of both new and existing homes are expected to reach record highs for a fifth straight year.

Some economists have begun to worry that a speculative bubble is developing in housing that will eventually burst — in the same way the stock market bubble burst at the beginning of this decade. While Mr. Greenspan has talked about “froth” in local markets, he has discounted concerns that a national housing bubble is developing.

Many economists believe that mortgage rates should begin rising gradually as the Fed keeps pushing short-term rates higher. They are forecasting 30-year fixed-rate mortgages around 6.5 percent by the end of this year, up about one percentage point from current rates.

The 30-year mortgage dropped to 5.53 percent this week, according to a Freddie Mac survey, the lowest level in more than a year.

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