The Federal Reserve, noting recent signs of economic strengthening, yesterday raised a key short-term interest rate for the fourth time this year to prevent inflationary pressures from building.
Fed policymakers, in a statement issued after their rate-setting meeting, sounded slightly more upbeat about the economy's performance than after their previous meeting in September, leading many financial analysts to conclude that the central bank will nudge up its benchmark rate again in December.
Brokers at the Chicago Mercantile Exchange react to the Federal Reserve's decision to raise a key rate by a quarter percentage point.
(John Gress -- Reuters)
Ticking Up The federal funds rate rose another quarter of a percentage point yesterday.
But some observers cautioned that the Fed officials' statement left open the option of leaving rates unchanged at the central bank's meeting next month if the economy falters. Economic output "appears to be growing at a moderate pace despite the rise in energy prices, and labor market conditions have improved," Fed officials said in their statement.
The policymakers decided unanimously to raise the federal funds rate -- the rate charged on overnight loans between banks -- to 2 percent from 1.75 percent. The rate influences many other business and consumer borrowing costs, which are determined by financial markets.
Banks responded by raising their prime lending rate for business loans to 5 percent from 4.75 percent. Consumer rates that are linked to the prime rate, such as those on many home equity loans and credit cards, may rise by as much.
Stocks were little changed by the close of trading yesterday, in part because the Fed action had been widely anticipated in financial markets. Stocks rallied initially, as investors interpreted the Fed's economic assessment yesterday as sunnier than before. The Fed's action marked its fourth consecutive rate increase since late June, when the funds rate was at 1 percent -- the lowest level since 1958. Fed officials started raising the rate at their June meeting after leaving it at 1 percent for the previous year, providing an "emergency" level of economic stimulus to support a wobbly economic expansion and prevent deflation -- a damaging drop in the overall price level.
At 2 percent, the rate is still very low and should continue to stimulate economic growth by encouraging borrowers to keep spending.
The Fed's rate increases so far have had no noticeable slowing effect on the economy. Longer-term interest rates, while influenced by the Fed, are determined by financial markets in response to a variety of factors and have remained relatively low in recent months.
For example, the national average rate on a 30-year mortgage reached its highest point this year in May, at 6.34 percent, and has drifted generally lower since. The average rate was 5.7 percent last week, compared with 5.94 percent in the same week a year ago. Low mortgage rates, in turn, have continued to stoke the booming housing market, providing a significant source of economic growth.
Low long-term rates generally reflect the financial markets' expectations of tame inflation and modest economic growth in the months ahead, which implies continued mild demand for business loans.