By hiking short-term interest rates slightly Tuesday, the Federal Reserve Board showed its willingness to take prudent steps now and likely down the road to protect the nation’s six-year-old economic expansion.
Many experts predict the central bank will make at least one more tightening move by the summer, followed by others if the U.S. economy doesn’t show signs of slowing.
In its much-expected move, the Federal Open Market Committee voted Tuesday to raise the federal funds rate to 5.5 percent from 5.25 percent, the first increase in the overnight rate charged between banks in more than two years.
“History tells us that the brakes have to be tapped just a little harder,” explained Roger Brinner, an economist with DRI-McGraw Hill, a financial forecasting firm in Lexington, Mass.
But analysts were divided on how fast the Fed will move and how far it will go to raise interest rates, part of a widespread debate about an economy that has confounded many experts because of its persistent low inflation and low unemployment levels, an unusual combination.
Essentially, the Fed said the economy is doing too well and needs some slowing down or else inflation will heat up, stalling the sustained growth.
Some business leaders, politicians and economists disagreed with the Fed’s action, accusing it of chasing after a ghost of inflation and other financial phantoms at the cost of billions to the economy.
They warned that it would derail the economy, not protect it against inflation. Even the strongest critics agreed, however, that such a small increase in short-term interest rates is unlikely to do much damage.
“I just don’t believe in a pre-emptive strike against inflation when you can’t find it,” said Robert Eisner, a Northwestern University economics professor.
“In one fell swoop, the Fed has taken money out of the pockets of every family, small business and farm in America,” complained U.S. Sen. Tom Harkin (D-Iowa), a vocal critic of Federal Reserve policy under Chairman Alan Greenspan.
The Fed action, however, does provide the benefits of higher interest rates to savers.
For consumers and businesses, the increase is likely to have several other ripples. Among them:
– The torrid stock price increases and wave of investor enthusiasm seen until recently on Wall Street is likely to cool.
– Home sales, which have been nearing record levels, are likely to slow somewhat, but a healthy spring housing market still is expected. Mortgage rates will continue to climb in anticipation of another tightening by the Fed.
– The price of imported products will grow more competitive with U.S. goods as the dollar grows to higher levels. This should spur some U.S. firms to keep their prices down to match the foreign competition, dampening inflation.
– Banks will push up their prime lending rates, boosting the cost of borrowing money on credit cards, auto loans, home equity loans and adjustable-rate mortgages.
The Fed left the largely symbolic discount rate, for short-term loans the system makes to banks, unchanged at 5.0 percent.
The move in the federal funds rate did not markedly affect Wall Street, which adjusted to the likelihood of the interest-rate increase in the last month.
After climbing 50 points early in the day, the Dow Jones industrial average eventually headed downward, losing 29.08 points to close at 6876.17. In the bond market, the yield on the Treasury’s 30-year bond rose to 6.97 percent from 6.92 percent Monday.
Reacting to the Fed’s move, Banc One of Columbus, Ohio, the nation’s ninth-largest bank, quickly boosted its prime rate, the rate charged its best customers, to 8.5 percent from 8.25 percent.
New York-based Citicorp, the second-largest U.S. bank, and Norwest Corp. of Minneapolis made similar increases.
Despite anticipation of the Fed’s step and growing unease on Wall Street, consumers still appear rather upbeat, according to the latest figures released Tuesday by the Conference Board.
The group’s consumer confidence index for March slipped slightly, but remained near a decade-high level, the New York-based business research group said.
Consumers in the nation’s heartland, from the Great Lakes to the Gulf of Mexico and west to the Rockies, continued to be the most optimistic, the organization said.
In a terse statement explaining its action, the Federal Open Market Committee said the move in the federal funds rate was taken against a background of “persistent strength in demand.” This could erode the low inflation that, the committee explained, has nurtured the nation’s economic growth.
“It’s an insurance policy. A little bit of tightening now saves a lot of tightening later,” said Michael Penzer, an economist with the Bank of America in San Francisco.
“This has to be one of the best premeditated, best preplanned tightenings ever,” Penzer added, referring to Greenspan’s frequent comments in the last few months about the dangers of inflationary pressures overtaking the economy.
To be sure, several economists noted that consumer spending for the first quarter of 1997 may be the highest since the last quarter of 1992.
“Greenspan has been wrong about the economy, and finally he had to admit his error. They underestimated consumer spending,” said David Hale, an economist with Zurich Kemper Investments of Chicago.
On the other hand, Bruce Steinberg, an economist with Merrill Lynch in New York City, noted that the economy appears to be slowing already. Consumer spending, he predicted, is likely to weaken during the second quarter.
David Lereah, chief economist for the Mortgage Bankers Association in Washington, said the Fed’s action was clearly “the beginning” of several interest-rate hikes.
A number of economists say short-term interest rates are likely to climb to 6 percent a year from now. Others, however, say the Fed may push the rate up that high before the end of the year.
Traditionally, when the Fed tightened interest rates, it does so sequentially. But some economists say the situation today is different–namely, the lack of any major inflationary signs is likely to lead the Fed to move conservatively.
