Federal Reserve officials, confident that hurricanes Katrina and Rita slowed the economy only temporarily, raised their benchmark short-term rate yesterday and indicated that they are likely to keep nudging it higher to keep inflation under control.
The Federal Open Market Committee, in a statement released after its meeting, noted that rebuilding the Gulf Coast areas devastated by the storms will spur economic growth in coming months. Meanwhile, the committee again expressed concern that higher energy prices and other costs may add to inflation pressure.
The Fed was saying, "Our radar screen is flashing red, and we're going to continue to boost rates until the inflation genie is back in the bottle," said Richard A. Yamarone, director of economic research at Argus Research Corp.
The committee unanimously agreed to lift its benchmark federal funds rate from 3.75 percent to 4 percent, the highest rate in more than four years. It was the 12th consecutive increase since June 2004, when the rate was 1 percent, a four-decade low.
Fed Chairman Alan Greenspan and his colleagues on the committee indicated that they view the rate as still low enough to stimulate economic activity and said they would probably keep lifting it at a "measured" pace, which has come to mean an increase of a quarter-percentage point at each scheduled committee meeting.
Futures contracts linked to the federal funds rate reflect market expectations that the Fed will raise it to 4.5 percent by Jan. 31, Greenspan's last day in office.
Some analysts predict that the rate will be raised as high as 5.5 percent by July before the increases stop, which assumes that Greenspan's successor will want to keep raising it for several months. President Bush has nominated his top economic adviser, Ben S. Bernanke, to become Fed chairman next year. Bernanke, a former Federal Reserve governor and former Princeton University economics professor, appears likely to win Senate confirmation with little opposition.
Bernanke may want to preside over a few rate increases at the outset of his term both to keep the lid on inflation and to dispel any doubts about his determination to do so, analysts said.
"Failure to continue the rate hikes might send undesired signals," Yamarone said. "Wall Street might interpret inaction as a 'dovish' attitude toward inflation, which is not exactly the confidence-instilling measure that a new Fed chair would wish to send to the global financial markets."
Higher borrowing costs dampen consumer and business spending, which softens demand and makes it harder for companies to raise prices.
The federal funds rate, the interest rate charged between banks on overnight loans, influences many other borrowing costs. Major banks followed the Fed's action by raising the prime rate on business loans to 7 percent from 6.75 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.
Long-term rates, such as those charged on 30-year mortgages, are determined by global financial markets in response to many factors. Home loan rates have been rising recently. The average rate on a 30-year, fixed-rate mortgage last week was 6.15 percent, up about half a percentage point from a year earlier, according to mortgage finance company Freddie Mac.
With yesterday's action, the Fed has raised the federal funds rate by three percentage points in 16 months. The Fed last raised the rate by that much in 1994-95, when it rose from 3 percent to 6 percent in 12 months. At that time, the central bank acted more aggressively than the markets expected, triggering turmoil in the bond market that contributed to the Mexican peso crisis; the Orange County, Calif., bankruptcy; and the failure of investment bank Kidder Peabody & Co. The recent increases, in contrast, have been anticipated in the markets and absorbed with no such distress.
The economy has been growing smartly even with rising interest rates and energy prices. The nation's gross domestic product, the value of all goods and services produced, rose at a 3.8 percent annual rate in the third quarter after expanding at a 3.3 percent pace the previous quarter, the Commerce Department said Friday.
Many analysts thought the economy might slump after the hurricanes sent energy prices up, wiped out thousands of jobs and disrupted shipping systems. Fed officials also worried that high energy prices had caused consumers to expect higher prices for other products, which might have pushed inflation higher. However, energy prices have since retreated from their post-hurricane highs.
More than 500,000 workers filed new claims for unemployment insurance benefits because of the storms, but job growth remained strong in September outside the Gulf Coast region, according to the Labor Department.
At the Fed's previous meeting on Sept. 20, one board member dissented from the decision to raise the benchmark rate because of the uncertainty of the economic outlook. By yesterday's meeting, all 10 voting committee members agreed that "elevated energy prices and hurricane-related disruptions in economic activity have temporarily depressed output and employment."
Energy prices did push inflation higher last month. But price increases have remained tame except those for food and energy in recent months, the committee noted.
Oil has been trading for about $60 a barrel, about double the price two years ago. The committee appeared to refer to the effects of that increase over time by expressing its concern that "the cumulative rise in energy and other costs have the potential to add to inflation pressures."