Fed Lifts Benchmark Interest Rate to 3.25%

By Nell Henderson
Washington Post Staff Writer
Friday, July 1, 2005

Federal Reserve officials, expressing confidence about the economy's strength and concern about price pressures, raised their key short-term interest rate yesterday and indicated they are likely to keep lifting it gradually higher to keep the lid on inflation.

"The expansion remains firm and labor market conditions continue to improve gradually," the central bank's top policymaking group, the Federal Open Market Committee, said in a statement after nudging its benchmark federal funds rate to 3.25 percent from 3 percent.

The group has raised the rate in nine quarter-percentage-point steps over the past year from a four-decade low of 1 percent. During that time, the economy has expanded at a healthy pace, while unemployment has fallen and price inflation for items other than energy has remained tame.

But Fed officials remain concerned about the potential for future inflation, citing rising labor and energy costs. They note that businesses are finding it easier to raise prices. And they are studying whether the nation's booming housing market is helping push up consumer prices.

"Pressures on inflation have stayed elevated," the Fed said, explaining its decision.

Stocks fell after the announcement, as investors concluded that short-term interest rates will keep rising for a while.

"There's nothing here to hint that the rate hikes might stop soon," Ian C. Shepherdson, chief U.S. economist for High Frequency Economics Ltd., wrote in an analysis of the Fed statement. "If anything, the hint is the other way."

Fed officials repeated that they probably can keep raising the federal funds rate, the overnight rate charged between banks, at a "measured" pace in the months to come.

After nine quarter-percentage-point moves, many investors have come to believe that "measured" means more of the same. But Fed officials say the language implies the possibilities of a half-point rate increase or a pause in the credit-tightening process, depending on how the economy performs.

The federal funds rate influences many other interest rates in the economy. Major banks followed the announcement by raising their prime rate on business loans by a similar quarter percentage point, to 6.25 percent from 6 percent. Consumer loan rates tied to the prime rate, such as those on many credit cards and home equity loans, may rise as well. Banks and other financial institutions may raise the rates they pay on savers' certificates of deposit and money market funds.

But longer-term interest rates, including mortgage rates, are determined by global financial markets and remain very low. The average rate for a 30-year, fixed mortgage fell last week, to 5.53 percent, the lowest level in 14 months, according to Freddie Mac, the mortgage finance company.

Meanwhile, the federal funds rate remains low enough to stimulate economic growth, the Fed noted, calling the level "accommodative."

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