Fed Keeps Rate on Rise
Statement Hints That Series of Increases Might End Soon

By Nell Henderson
Washington Post Staff Writer
Wednesday, December 14, 2005

Federal Reserve officials, expressing concern that strong economic growth may fan inflationary pressures, raised their benchmark short-term interest rate again yesterday and indicated that they will lift it again next year to keep the lid on price increases.

Fed policymakers have raised the rate steadily over 19 months and suggested that they may do so again at their next meeting Jan. 31, which is also Fed Chairman Alan Greenspan's last day on the job. They indicated, though, that they might be nearing the end of this series of rate increases.

But they did not foreclose the possibility of more rate increases after Greenspan steps down, leaving the options open for his likely successor, Ben S. Bernanke.

"Some further measured policy firming is likely to be needed," the policymakers' Federal Open Market Committee said in a statement after its meeting yesterday, referring to the likelihood of one or more small rate increases to come.

The committee unanimously agreed to raise its federal funds rate to 4.25 percent from 4 percent. It was the 13th consecutive quarter-percentage-point increase since June 2004, when the rate was 1 percent, a four-decade low.

Stocks rallied on investor hopes that the central bank might soon stop raising the rate, perhaps after nudging it to 4.5 percent next month.

The Fed's statement "points to light at the end of the monetary tightening cycle," said Brian A. Bethune, U.S. economist at Global Insight, a financial firm that is forecasting that the Fed will stop after moving the benchmark rate to 4.75 percent in late March.

Some analysts are predicting that the rate will rise as high as 5.5 percent before the Fed is finished.

The decision about when to stop raising the rate probably will be made after Greenspan retires, by an FOMC led by Bernanke, a former Fed board member who is now President Bush's top economic adviser. Bernanke has pledged "continuity" with Greenspan's policies.

The Senate is likely to confirm Bernanke's nomination next month, enabling him to take over as Fed chairman Feb. 1. The next FOMC meeting after that is scheduled for March 28. Before that meeting, Bernanke will present the Fed's semiannual economic policy report to Congress and will have an opportunity in public testimony to signal the markets about his intentions.

The federal funds rate, which is charged on overnight loans between banks, influences many other borrowing costs. Major banks followed the Fed's action yesterday by lifting the prime rate on business loans to 7.25 percent from 7 percent. Many consumer rates, such as on credit cards and home equity loans, may rise as well. Banks and other financial institutions may increase the rates they pay on certificates of deposit and money market funds.

However, the Fed does not control long-term interest rates, such as those on mortgages and many business loans, which are determined by global financial markets and remain historically low.

Several Fed officials have noted recently that the economy has plenty of momentum as it enters the new year. Businesses are investing and hiring, the housing market is cooling but still going strong, and the government is pouring billions of dollars into rebuilding areas devastated by the recent hurricanes.

"Despite elevated energy prices and hurricane-related disruptions, the expansion in economic activity appears solid," the FOMC said in its statement yesterday.

Inflation outside of food and energy prices has remained low, the Fed noted. But businesses may feel growing pressure to raise consumer prices because energy costs remain high, labor markets are tightening and many companies are boosting production, the committee suggested.

After the 2001 recession, unemployment was higher and many businesses had more factory capacity, office space and other resources than they could use -- a condition Fed officials referred to as "slack" in the economy. They cut the benchmark rate to 1 percent in June 2003, drastically lowering borrowing costs to stimulate spending and investment, spurring the economy to grow faster and gradually absorb that slack.

Now, many Fed officials think there is little slack left and some are becoming concerned that fast economic growth could drive up labor costs and create production bottlenecks, possibly pushing up inflation as well.

"Possible increases in resource utilization . . . have the potential to add to inflationary pressures," the statement said.

For many months, several Fed officials said they intended to raise the federal funds rate from a low "accommodative" level that stimulates economic growth to a neutral level that neither spurs nor restrains growth. The Fed statement yesterday dropped "accommodative" as a description of the rate, suggesting it is in more neutral territory.

But some policymakers are considering whether they may have to keep raising the benchmark rate even higher, slowing economic growth a bit to keep inflation pressures in check.

Higher consumer and business borrowing costs dampen spending, which softens demand and makes it harder for companies to raise prices, squelching inflation.

If by late March, inflation remains tame and inflationary pressures have receded, the Fed might leave the rate unchanged. Or if the economy is growing rapidly, businesses are raising prices, labor costs are rising or consumers indicate they expect higher inflation, the committee could keep raising the rate.

If the economic outlook is ambiguous, a new chairman is more likely to raise interest rates to establish his inflation-fighting credentials with financial markets, said David H. Resler, chief economist of Nomura Securities International Inc. "A new Fed chairman is going to have a tendency to be more restrictive," he said.

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