20000204

Fed raises US rates, warns of more to come

WASHINGTON: The Federal Reserve cautiously raised US.interest rates on Wednesday and signalled more increases are likely, warning that inflation was the main threat to the nation's longest-ever economic expansion.

In line with widespread expectations in financial markets, the powerful central bank marked the 107th uninterrupted month of U.S. growth by lifting its target for the federal funds rate on overnight loans to banks to 5.75 percent from 5.5 percent.

To amplify its move, the rate-setting Federal Open Market Committee also raised the less-used discount rate on direct loans to banks to 5.25 percent from five percent.

Investors took the decision in stride. Inflation-sensitive bond prices remained firm after the Fed's announcement. Stocks closed mixed with the blue-chip Dow Jones industrial average modestly lower but technology stocks on the Nasdaq higher.

Major U.S. banks quickly followed the Fed's lead and raised their prime rates, which determine the cost of bank credit.

Explaining its decision, the Fed said: "The Committee remains concerned that over time increases in demand will continue to exceed the growth in potential supply, even after taking account of the pronounced rise in productivity growth."

"Such trends could foster inflationary imbalances that would undermine the economy's record economic expansion," the statement added, reflecting similar language adopted by the Fed after its December rate meeting.

STAND BY FOR MORE

Using a new procedure announced last month to signal its future intentions, the Fed said that the risks for the economy were "weighted mainly toward conditions that may generate heightened inflation pressures in the foreseeable future."

Financial markets read that statement as a warning shot intended to signal that the Fed will bump up borrowing costs once again at its next policy meeting on March 21.

A Reuters poll after the FOMC decision found that 26 of the 30 leading banks and brokerages on Wall Street expect the Fed to raise rates by a quarter point in March. Half of the firms said the fed funds rate would reach at least 6.25 percent by mid-year.

The new wording of the Fed's leaning on future rate moves replaced the previous routine of announcing a so-called "policy bias," which financial markets -- and, eventually, Fed officials -- found to be more confusing than enlightening.

"It's a reasonable consensus expectation that the Fed is going to tighten further, that the next move probably will come at the next meeting in March," said Neal Soss, chief economist at Credit Suisse First Boston in New York. He added that he expects a "couple more" rate rises before the end of the year.

The Fed's move, which will make borrowing more expensive for consumers and firms alike, came a day after the world's top economy entered its record-breaking 107th month of uninterrupted growth.

With economic growth running at a red-hot 5.8 percent annual rate at the end of last year, the Fed worries that rising price and wage pressures may spell a premature end for the expansion -- despite what it described in its statement as a "pronounced rise in productivity growth."

POTENTIAL PROBLEMS

"They feel that the pace of demand in the economy is faster than the potential growth rate, and that will cause problems down the road if it continues," said Michael Moran, chief economist at Daiwa Securities America in New York.

The Fed last raised rates on Nov. 16, the third in a series of moves started in June 1999 that took back the easings of the previous year. The fed funds rate is now at its highest level in almost five years.

The U.S. administration stuck to its policy of not commenting directly on decisions by the politically independent Fed. In a brief statement, Treasury Secretary Lawrence Summers and the head of President Bill Clinton's council of economic advisors, Martin Baily, said they "share" the Fed's goals of maintaining healthy growth while keeping a lid on inflation.

But the nation's manufacturers, worried that the Fed action will raise the cost of capital, said the central bank's fear of inflation was exaggerated. "That this decision is unsurprising makes it no less unnecessary," Jerry Jasinowski, head of the National Association of Manufacturers, said in a statement.

Fed Chairman Alan Greenspan will have to defend Wednesday's decision before U.S. lawmakers on Feb. 17 in his twice-annual report to Congress, known as the Humphrey-Hawkins testimony.

The Fed's decision was announced as the U.S. Senate started debating Greenspan's nomination to a fourth term at the helm of the central bank. The vote was largely seen as a formality as lawmakers are overwhelmingly supportive of his 13-year record.

But North Dakota Democratic Senator Byron Dorgan, a long-time critic of Greenspan, was a voice of dissent. "The Federal Reserve is placing a tax on every single American with these rate hikes," he said. "The Fed has been consistently wrong."-Reuters