Some Federal Reserve policymakers worried last month that inflation dangers were growing and that low interest rates might be encouraging excessively risky investments, including speculative home buying.
Members of the Fed's top policymaking committee discussed those concerns at their last meeting, Dec. 14, according to minutes released yesterday. The committee concluded by raising the Fed's benchmark short-term interest rate and signaling that it would lift the rate gradually higher this year.
Stock prices fell after the minutes were released yesterday afternoon. Wall Street "clearly interprets these comments as those of an inflation-fearing Fed that is moving from simply tapping on the brakes to slamming on the brakes," said Richard A. Yamarone, director of economic research at Argus Research Corp.
Despite the risks cited, Fed officials "generally expected that inflation would remain low in the foreseeable future," the minutes show. The committee expressed that sentiment in the statement it released after the meeting, while repeating that it would likely continue to raise the benchmark federal funds rate at a "measured" pace, which has meant small increases spread over many months.
The Fed raised the rate to 2.25 percent from 2 percent at the December meeting. That was the fifth quarter-percentage-point increase since June, when the rate was 1 percent.
Fed officials lowered the funds rate to 1 percent in June 2003 to encourage more borrowing and spending in a then-sluggish economy and to prevent deflation, a dangerous drop in overall prices. With deflation fears gone and the economic expansion on track, the Fed started raising the rate in June 2004 to prevent easy money from fueling inflation.
Fed officials have indicated that they want to move the funds rate, charged on overnight loans between banks, closer to a level that would neither spur nor slow economic growth. While Fed policymakers disagree about what such a neutral rate might be, many economists have predicted that the central bank will raise the funds rate to 3 to 4 percent by year-end.
Some analysts considered whether they should revise those forecasts higher after reading the December meeting minutes, which summarize the discussion without identifying the participants by name.
According to the minutes, some committee members expressed concern that inflation might be fanned by high oil prices, a falling dollar, strong economic growth and rising labor costs.
Others countered that the dollar's fall will probably have a limited effect on consumer prices, that wage growth has been moderate and that fat profits should enable businesses to absorb many rising costs without increasing prices.
Some policymakers worried that the Fed's policy of holding interest rates very low for several years had encouraged so much borrowing -- and put so much more money in circulation -- that it might have led some companies and traders to engage in riskier transactions. They cited the relatively narrow differences, or "spreads," between yields on low-risk Treasury securities and higher-risk corporate bonds -- a sign that many investors might be underestimating the risks of the corporate bonds. They also noted anecdotal reports of speculative home buying.
"Some participants believed that the prolonged period of policy accommodation had generated a significant degree of liquidity that might be contributing to signs of potentially excessive risk-taking in financial markets," the minutes said.
To financial markets, the comments about inflation and investment risks sounded like "a warning shot across the bow" that the Fed might have to move the funds rate above neutral this year, to a level that would slow growth, said Laurence G. Kantor, global head of economics and market strategy at Barclays Capital. "This is about as hawkish as the minutes get."
Others said the minutes echoed Fed officials' comments indicating that they plan to keep raising rates for a while. William C. Dudley, chief economist at Goldman Sachs U.S. Economics Research, said the minutes reflect "the Fed's resolve to stay on course."
