Federal Reserve officials lifted their key short-term interest rate last month because most of them worried that Hurricane Katrina had done more to raise the risks of higher inflation than to threaten U.S. economic growth.
Members of the Fed's top policymaking committee also believed more rate increases would probably be needed to keep a lid on price increases, according to minutes released yesterday of the group's Sept. 20 meeting.
One Fed board member, Mark W. Olson, dissented at the meeting because he wanted to leave the rate unchanged until he had more information on the deadly storm's economic effects, the minutes state, providing the first public explanation of his vote.
The committee reported Olson's action after the meeting -- the first dissent at a Fed policymaking meeting in more than two years. But until the minutes were released, the central bank had provided no reason for why Olson broke with Chairman Alan Greenspan and the rest of his colleagues.
Until yesterday, many analysts had wondered if other members of the committee had also advocated a pause in the Fed's series of rate increases. The minutes, however, give no sign that any other committee member agreed with Olson's position.
"Although uncertainty had increased, in the Committee's judgment, the fundamental factors influencing the longer-term path of the economy probably had not been affected by the hurricane, but the [risks of higher] inflation appeared to have increased," the minutes said, summarizing the discussion without identifying the speakers by name.
Fed officials also worried that a decision to leave the rate unchanged might send the wrong message, suggesting that they were more worried about the economy or were not determined to keep inflation under control.
The nine other voting members of the Fed committee agreed to raise the benchmark federal funds rate, the overnight rate charged on loans between banks, to 3.75 percent from 3.5 percent, for an 11th consecutive increase.
They also agreed that "further rate increases probably would be required" because the interest rate was still too low to keep the lid on inflation, the minutes show.
The Fed's benchmark rate influences many other interest rates charged on consumer and business loans. Low rates encourage people to borrow and spend, causing the economy to grow faster. That is good when the economy is in a slump, but it can fuel inflation when growth is strong and the demand for goods or services rises faster than the supply. Higher rates, conversely, restrain spending, which slows the economy and dampens price pressures.
The Fed staff had recently revised its forecasts to predict higher inflation this year and higher consumer prices for items other than food and energy, or core inflation, next year, the minutes said, without revealing the numbers.
The minutes do not indicate how high the benchmark rate might go before the Fed rests. Immediately after Katrina devastated much of the Gulf Coast, fueling predictions of a sharp slowdown in growth, many analysts and investors in futures contracts predicted the Fed might stop after increasing the rate to about 4 percent. But expectations have moved higher since the meeting, as several Fed officials have expressed heightened concern about inflation at a time of high energy prices, rising costs for many building materials, a healthy labor market and federal government plans to spend billions of dollars on recovery efforts.
"The primary concern for the outlook is that higher costs may lead to greater inflation," Thomas M. Hoenig, president of the Federal Reserve Bank of Kansas City, said last week.
By yesterday afternoon, investors in futures contracts linked to the federal funds rate were projecting it to reach about 4.5 percent by March. Some analysts, such as those at Goldman Sachs US Economic Research, are predicting the rate will go as high as 5 percent before the Fed is finished.
Macroeconomic Advisers LLC, a St. Louis forecasting firm, last week predicted the Fed will stop after increasing the rate to 4.75 percent, up from its previous call of 4.5 percent. The firm raised its estimate for the rate primarily because of the rising estimates of the amount of federal money to be spent on Gulf Coast reconstruction.
Fed officials believe the rate is still so low it is stimulating spending and economic growth. They have spoken for more than a year about moving it to a more neutral level that would neither spur nor restrain the pace of growth. Greenspan has declined to put a number on that level, but estimates range from 3.5 percent to 5.5 percent.
However, a Goldman Sachs analysis yesterday said the minutes show Fed "concerns about the inflation outlook have increased, making it more likely the Fed may have to go beyond a 'neutral' rate to stave off inflation."