Fed Raises Rate Again; Now What?

With 16th Straight Rise, Board Leaves Its Options Open

Traders work on the floor of the New York Stock Exchange, Tuesday May 9, 2006. Stocks were little changed in early trading as Wall Street awaited news on interest rates, although a profit warning from Dell Inc. weighed on the Nasdaq composite index. (AP Photo/Bebeto Matthews) (Bebeto Matthews - AP)

Federal Reserve officials raised a key interest rate again yesterday and signaled that they do not know whether they will need to move it still higher in coming months to prevent rapid economic growth from pushing inflation higher.

The policymakers suggested in a statement that they were keeping their options open, a message that disappointed many investors and analysts who had hoped for a clear sign that the Fed would pause in June and leave its benchmark interest rate unchanged after nearly two years of steady increases.

Stock prices fell sharply after the central bank's top policymaking group, the Federal Open Market Committee, announced its unanimous decision and issued a statement. But then stocks rallied, dropped and then rose again as investors reacted with confusion to the first FOMC statement in two years that did not hint at the central bank's likely next move.

"Some further policy firming may yet be needed to address inflation risks," the committee said, raising the possibility of at least one more rate increase.

At the same time, the FOMC suggested that it does not know how many, if any, more increases are in store and that it may pause at its next meeting in June if economic growth slows and inflation pressures ebb. The committee "emphasizes that the extent and timing of any such firming will depend importantly on the evolution of the economic outlook" in response to new data.

"The FOMC has opened the door for a pause, but this does not necessarily mean the FOMC will go through that door at their June meeting," wrote economists at PNC Financial Services Group Inc.

The committee agreed unanimously to lift its benchmark federal funds rate, the interest rate charged on overnight loans between banks, to 5 percent from 4.75 percent, its 16th consecutive quarter-percentage-point increase since June 2004.

"Economic growth has been quite strong so far this year," the committee said, expressing concern that a strong job market, high prices for energy and other raw materials, and other factors could increase inflation pressures.

But the FOMC also said it expected economic growth to slow as rising interest rates, a cooling housing market and higher energy prices crimp consumer spending. That should tamp down inflation pressures.

If the economy slows as forecast and inflation pressures ease, Fed officials probably will not raise the benchmark interest rate again anytime soon. But if their forecast is wrong -- if robust growth causes inflation risks to rise -- they might raise the rate again in June, and possibly again after that.

"The statement gives the Fed options either way," wrote Ian Shepherdson, chief U.S. economist for High Frequency Economics Ltd., in an analysis for clients.

The benchmark rate, now at its highest level in more than five years, influences many other borrowing costs in the economy. Major banks followed the Fed's action by raising the prime rate charged on business loans to 8 percent from 7.75 percent. Lenders are also likely to bump rates higher on many consumer loans, such as on credit cards, home-equity loans and mortgages. Savers will likely benefit as banks and other institutions raise rates paid on money-market funds and certificates of deposit.