- The Washington Times - Tuesday, August 8, 2006

The Federal Reserve yesterday decided against raising interest rates for the first time in more than two years, noting that growth is slowing rapidly so inflation should subside as well.

But the central bank, after a daylong meeting of its rate-setting committee, said it will resume raising rates if inflation does not die down from today’s elevated levels — a warning that eclipsed the initially ecstatic reaction in financial markets to the Fed’s rate pause and sent the stock market tumbling.

“Economic growth has moderated from its quite strong pace earlier this year, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices,” the Fed said. “Nonetheless, the committee judges that some inflation risks remain.”

The dramatic slowdown in the housing market in the past year has been prompted by the Fed’s ratcheting up rates by 4.25 percentage points since June 2004. The many home buyers who took out adjustable-rate mortgages during the housing boom face big and potentially devastating adjustments in their loan payments as a result. Other interest-sensitive sectors such as cars and appliance sales also have been hurt by the Fed’s actions.

With interest rates at their highest levels in five years, most businesses and consumers from Wall Street to Main Street had hoped for a rest. But the long-sought hiatus in the Fed’s extraordinary string of rate increases — the longest unbroken stretch in decades — came after much indecision and wrangling both inside and outside the Fed over how damaging this year’s bout of inflation inspired by soaring energy prices will be.

A report from the Labor Department yesterday showed that labor costs — the biggest contributor to the prices set by businesses — rose at a robust 4.2 percent rate in the last quarter even as productivity gains — which tend to hold down inflation — waned to 1.1 percent.

“It was a tough decision. The economy is slowing, and oil prices are driving up inflation,” said Peter Morici, business professor at the University of Maryland.

But oil prices, which are set in global markets and affected by forces as varied as war in the Middle East to hurricanes in the Gulf of Mexico, “are beyond the reach of U.S. interest rate policy,” he said.

The Fed’s decision yesterday was not unanimous, including a rare dissent by Richmond reserve bank President Jeffrey M. Lacker, who pushed for a rate increase.

Inflation has picked up markedly this year and is outside the Fed’s “comfort zone,” said Bernard Baumohl, executive director of the Economic Outlook Group.

But he added that the Fed is right to assume that businesses will be unable to keep pushing through higher prices as long as consumer spending slows under the weight of mounting debts and energy prices.

Despite concerns about rapid price increases this year, Fed governors no doubt were troubled by recent reports showing that business investment spending is slowing along with consumer spending, rather than picking up to support growth, as the Fed had expected, Mr. Baumohl said. Businesses have concluded that they cannot afford to expand when consumers are retrenching, he said.

“A further rate increase at a time when 85 percent of the economy is slowing is just too dangerous,” Mr. Baumohl said. “Additional monetary tightening at this stage can sap so much oxygen out of the economy that it could precipitate a recession.”

Richard Yamarone, economist at Argus Research Corp., said the Fed made a “huge blunder” by not raising rates, giving a green light to businesses to keep raising prices.

The Fed’s own favorite measure of inflation — the core rate that excludes energy prices — jumped 2.9 percent in the latest quarter, the fastest since 1995.

Major companies that already have raised prices, including UPS and DuPont, say their costs are still going up, and many others have announced plans to pass higher costs on to consumers, Mr. Yamarone said. That list includes Anheuser-Busch, Kellogg’s, Interstate Bakeries, Sherwin-Williams, Reynolds American, Carnival, Goodyear, Colgate-Palmolive and Kraft Foods.

“The question we ask is: Why has the Federal Reserve opted to ignore these obvious signs of inflation?” Mr. Yamarone said. “We believe that sitting sidelined while inflation is rising at an 11-year high, price pass-alongs announcements are rampant, and labor, commodity and material costs are accelerating is simply irresponsible.”

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