WASHINGTON – The Federal Reserve (search), still concerned about inflation, raised a key interest rate on Tuesday to the highest level in more than four years and signaled more increases are likely.
The Fed announced it was pushing its target for the federal funds rate, the interest that banks charge each other, to 4 percent from 3.75 percent, where it had been since the Fed's last interest-rate meeting on Sept. 20.
It marked the 12th consecutive quarter-point increase since the Fed began gradually raising rates in June 2004 to make sure that a growing economy did not generate higher inflation.
Higher interest rates fight inflation by slowing economic activity. The higher rates dampen consumer demand for such items as autos and homes and raise the cost of borrowing for businesses.
On Wall Street (search), stocks had a brief rebound into positive territory after the Fed's mid-afternoon announcement but then lost ground on a disappointing earnings forecast from computer giant Dell Inc.
In a brief statement explaining Tuesday's action, the Fed retained language it has been using, which said it believes future interest rates can occur "at a pace that is likely to be measured." That phrase is seen as a signal that the Fed plans to keep raising rates at a gradual pace of quarter-point moves at coming meetings.
Tuesday's rate hike had been widely expected, given that a number of Fed officials in recent weeks have expressed worries that the sharp rise in energy prices that occurred in early September presented the danger of more widespread inflation pressures down the road.
The Fed rate increase was quickly followed by an increase in commercial banks' prime lending rate, led by Cleveland-based KeyCorp (search). The prime was raised by a quarter-point to 7 percent, the highest level for this benchmark for consumer and business borrowing, since June 2001.
Analysts noted that the Fed expressed the belief in its statement that economic activity will be boosted by post-hurricane rebuilding. "In other words, slower quarter four growth won't prevent more hikes," said Ian Shepherdson, chief U.S. economist for High Frequency Economics (search), a consulting firm in Valhalla, N.Y.
Many analysts believe the Fed will keep raising interest rates at its final meeting of this year on Dec. 13 and at its first meeting of 2006, on Jan. 31.
Two more quarter-point increases would push the funds rate to 4.5 percent at the Jan. 31 meeting, which will be Federal Reserve Chairman Alan Greenspan's final meeting. He is stepping down with the end of his term on the board, concluding more than 18 years at the central bank.
President Bush last week nominated Ben Bernanke (search), his top White House economic adviser to succeed Greenspan. Bernanke has said that his "first priority" will be to maintain continuity with Greenspan's policies.
The Fed statement retained language used after the September meeting indicating that the central bank believed Hurricane Katrina would have only a temporary impact on economic growth, with greater concerns about what the hurricanes would do to energy prices, given the shutdowns of Gulf Coast production facilities.
"The cumulative rise in energy and other costs have the potential to add to inflation pressures; however, core inflation has been relatively low in recent months and longer-term inflation expectations remain contained," the Fed said in its statement.
The increase pushed the funds rate to its highest level since it was at 4 percent in the summer of 2001, a time when the central bank was cutting interest rates to revive the economy.
The government reported last Friday that the overall economy grew at a solid annual rate of 3.8 percent in the July-September quarter. Private analysts said growth would have been well above 4 percent without the impact of the hurricanes.
People who know both Greenspan and Bernanke said Bernanke's pledge to follow Greenspan's policies is very credible when considering the close working relationship the two enjoyed when Bernanke served from 2002 to June of this year as a Fed board member.
A number of Fed officials in speeches in October voiced concern about the potential threat of rising inflation. The Fed's most recent survey of the economy, the Beige Book (search), noted that prices were increasing for everything from lumber and hardware to hotel rooms.
Also, the Labor Department reported that consumer prices in September shot up by 1.2 percent, the biggest one-month increase in a quarter-century, led by a record rise in energy prices. This reflected the impact of hurricane-forced production shutdowns along the Gulf Coast.
Many analysts believe that a funds rate at 4.5 percent would represent a "neutral" level which was not spurring economic activity or depressing further activity and the Fed would then be content to leave the funds rate there for some time. However, some analysts said that if inflation pressures are mounting, the Fed under Bernanke will keep raising rates to 5 percent or higher early next year.