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Federal Reserve Boosts Key Interest Rate

By Nell Henderson
Washington Post Staff Writer
Tuesday, December 14, 2004; 5:09 PM

Federal Reserve officials raised a key short-term interest rate today for the fifth time this year, and indicated they will continue to gradually move rates higher next year to contain inflation as the economy continues to expand.

The central bank policymakers decided unanimously to raise the federal funds rate, the interest rate charged between banks on overnight loans, to 2.25 percent from 2 percent. That leaves it 1.25 percentage points higher than when the Fed started raising rates in late June, after holding the rate for a year at 1 percent -- the lowest level since 1958.

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Video: The Washington Post's Nell Henderson discusses the Federal Reserve's decision to boost a key short-term interest rate by one-quarter percentage point.
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Federal Reserve Statement (Associated Press, Dec 14, 2004)

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Graphic: Historical Changes in the Federal Funds Rate
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Federal Reserve Special Report

The Fed's top policymaking committee repeated in the statement released after its meeting that it would likely raise the funds rate at a "measured" pace in the future. Analysts have interpreted the phrase to mean increases in small steps -- by a quarter- or half-percentage point at a time -- spread out over many months.

Over the last six months, the Fed raised the rate by a quarter-point at each of its five scheduled meetings. Analysts widely expect that pace to slow in the coming year. For example, the Bond Market Association said Monday its advisory panel of economists expects to see the funds rate rise to 3.5 percent by this time next year. That would mean raising the benchmark rate by as much all next year as it was raised in the last six months.

But the Fed's language deliberately leaves the central bank great flexibility to raise rates more aggressively if inflationary pressures flare, or to move more slowly if the economic expansion turns sluggish.

The Fed's next scheduled meeting is in early February, giving officials a relatively long seven weeks between policymaking sessions to assess how the economy is doing.

The fed funds rate influences other borrowing costs throughout the economy. Banks are likely to respond quickly by raising the prime rate charged on loans to their best business customers by a similar quarter point to 5.25 percent. Many consumer rates tied to the prime, such as on credit cards and home equity loans, may rise as well.

However, longer term rates are determined by financial markets, reflecting the overall demand for credit and inflation expectations. With that demand still mild and inflation tame, many long term rates remain relatively low.

Mortgage rates, for example, fell last week to levels below where they were a year before. The average rate on a 30-year fixed rate mortgage slid to 5.71 percent; a year ago it was 6.02 percent.

Stock prices were little changed after the Fed's action today, as the move had been very widely expected.


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