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More Expected Rate Hikes

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Feb. 4, 2005 -- For the sixth time since June, the Federal Reserve raised short-term interest rates on Wednesday, and signaled that future hikes are likely.

The overnight rate charged between banks now stands at 2.50%, up a quarter of a percent from the last Fed meeting. Since June, when the short-term rate was 1%, the Fed has increased the rate six times, all in quarter-point increments.

The Federal Open Market Committee (FOMC), the branch of Fed that moves the rate by buying or selling securities to lenders, said in a press release that the "monetary policy remains accommodative" for economic growth, and that inflation and inflation expectations remain contained. Because of these positive factors, the committee said it could continue to raise rates "at a pace that is likely to be measured."

While the Fed is optimistic about inflation, Richard Berner, Morgan Stanley's chief US economist, is not. "Inflation risks are in my view the Fed's most important challenge," Mr. Berner wrote last week in a newsletter. Atop Mr. Berner's concerns is the "pass through" of energy and commodities prices to consumers and productivity, which the government reported today to have grown only 0.8% last quarter, the slowest quarterly growth rate in nearly three years.

The policy-setters at the Fed are aware of these concerns, but have placed greater weight on the economy's upside, said Michael Moran, chief economist at Daiwa Securities. "I think most fed officials recognize the risks are out there, but at the same time felt there were enough arguments in the other direction, like the economy growing close to its potential rate and the existence of slack in the economy."

Mr. Moran believes the short-term rate will be 3.75% by year-end, and that tightening will continue in 2006.

The FOMC also raised the discount rate a quarter percent to 3.50%. The discount rate is the rate the central bank charges commercial banks, so Wednesday's news triggered many banks to hike their prime rate to 5.50% from 5.25%.

Last updated: Feb 3, 2005




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