The Federal Reserve today took another step to tighten its monetary policy, the second time in as many weeks the central bank has raised interest rates to cut down on credit expanison and slow the growth of the money supply.
Analysts said the Fed's steps today virtually guarantee that major banks will have to boost their prime lending rates to a record 12 1/4 percent starting next week.
By early September, according to Salomon Brothers economist Henry Kaufman, the prime rate will move to 12 1/2 percent even if the central bank takes no further steps to tighten credit.
William Sullivan, of the Bank of New York, said the central bank raised the target on its key interest rates from 11 percent to 11 1/4 percent.
Sullivan said the Fed's move helped push other short-term interest rates higher, although those rates have been rising all week anyway because of strong demand for funds on the part of businesses and the banks.
Rates on certificates of deposit, a major instrument used by banks to obtain funds to lend to customers, have climbed to over 11 percent, with the rates on longer-term, six-month certificates pushing 11.5 percent.
Rates on commercial paper, essentially short-term IOUs issued by corporations that need cash and bought by corporations with spare funds, are averaging about 10 percent.
Sullivan said the Federal Reserve's move today pushed up interest rates on certificates of deposit by about 20 basis points ( a basis point is 1/100 of a percentage point) and commerical rates about 5 to 10 basis points.
Despite recent strong steps by the Federal Reserve to halt the expansion of credit and reduce money supply growth, borrowing has continued to remain strong.
Commercial and industrial loans at major New York banks grew by $102 million in the week ended last Wednesday. The money supply -- checking desposits plus currency in circulation -- jumped $1.8 billion in the week ended Aug. 15.
For the last 13 weeks, the money supply as been growing at an annual rate of 9 percent, much faster than the 4.5 percent target the Fed has set for it.
The money supply is the amount of funds that businesses and individuals have to spend without dipping into savings. Money supply growth is considered key to both inflation and economic growth, although economists are not in agreement on just how important money growth is as an economic variable.
Last week the Federal Reserve raised the targets of its key federal funds rate from 10 5/8 percent to 11 percent and boosted its discount rate to a record 10 1/2 percent from 10 percent.
The federal funds rate is the interest banks charge each other for over night loans of excess reserves. The Federal Reserve controls that rate by buying and selling government securities in the open market, alternately drying up funds banks might otherwise lend or supplying funds they can lend.
In response to rising market interest rates -- especially on certificates of deposit -- major banks last week raised their prime lending rate to 12 percent.