- The Washington Times - Thursday, June 29, 2006

The Federal Reserve raised interest rates another quarter-point yesterday but backed off recent tough rhetoric, saying an impending slowdown from the rousing 5.6 percent growth rate of the first quarter should do much to tame this year’s troubling spike in inflation.

The sudden softening by the Fed, whose members had vowed in speeches earlier this month to vanquish “unwelcome” inflation at nearly any cost, soothed investors and sparked powerful rallies in Wall Street stock and bond markets.

The Dow Jones Industrial Average, already boosted yesterday by the robust first-quarter growth reading from the Commerce Department, soared after the Fed’s statement and closed up 217 points at 11,191, in its biggest jump since 2003.

“This is good news for the equity markets and for the economy,” said Bernard Baumohl, executive director of the Economic Outlook Group, an economic advisory firm in Princeton, N.J. The Fed acknowledged that the economy is slowing under the weight of high energy prices, a cooling housing market and the substantial rate increases the Fed previously ordered over the last two years. It said inflation is likely to recede from recent high-water levels as well.

Despite all the “dire warnings and threats” when core inflation readings surged over the Fed’s 2 percent comfort zone last month, “evidently this Fed is not about to raise rates more precipitously and risk a serious economic downturn just to prove a point,” Mr. Baumohl said.

“The sooner the Fed stops, the more confident we can be that they don’t do any further damage to growth,” said Bob Sitko, fund manager at USAA Private Investment Management.

The Fed statement said it still sees a risk of higher inflation resulting from elevated prices for energy and other commodities. The price of premium crude oil jumped to within $2 of its record high over $75 a barrel in New York trading yesterday, and some energy analysts are predicting further pressure on gasoline prices as consumers take driving vacations this summer. Also, sharply higher electricity rates are hitting Washington and other areas.

But the Fed said the biggest component of consumer prices — labor costs — has been held down by rising productivity and inflation expectations overall remain contained. It said it would watch closely how both growth and inflation fare in coming weeks in deciding whether to raise rates further.

Wells Fargo senior economist Scott Anderson said the markets rejoiced because many on Wall Street feared the Fed would follow up its strident anti-inflation rhetoric in recent weeks by doubling the size of its usual quarter-point rate increase in short-term rates to a half percentage point. Such a large rate increase would have signaled the Fed was willing to sacrifice growth to hammer inflation.

Instead, the Fed raised its bank lending rates by another quarter-point, prompting major banks to adopt a like-sized incremental rise in the prime rate and other loans.

“The statement was not as hawkish on inflation as expected,” Mr. Anderson said. Wells Fargo expects economic reports in coming weeks to show further progress at moderating inflation and growth.

“We think the housing markets and the consumer cooling down will put a lid on inflation. Additionally, you could see commodity and gasoline prices come down,” he said.

While public opinion polls show Americans overwhelmingly would like the Fed to stop raising rates, not everyone was happy with the Fed’s more conciliatory stance.

Lawrence Kudlow of Kudlow & Co. said the Fed’s new chairman, Ben S. Bernanke, needed to establish his “monetary manhood” with a big rate increase. He said it was a bad sign that gold prices and commodity stocks rose on news of the smaller increase. The dollar also fell on the Fed’s move, raising the likelihood that prices of oil and other imports will continue to increase.

“No one is afraid of a quarter-point rate hike,” Mr. Kudlow said. “I’d like to see some fear in the inflation stocks, but I’m seeing greed instead.”

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