Fed hits pause button on rate hikes

Wed, Aug 9 2006 07:16 GMT


WASHINGTON
The Federal Reserve, after engineering the longest unbroken string of interest rate hikes in recent history, has finally hit the pause button.
The big question now is whether the reprieve for millions of borrowers will be temporary or a permanent halt in the central bank's campaign to slow the economy as a way of keeping inflation from getting out of hand.
At its meeting Tuesday, the Fed announced it was leaving the federal funds rate unchanged at 5.25 percent, marking the first time it has skipped raising rates since it began a two-year credit tightening drive in June 2004.
The funds rate, which was at a 46-year low of 1 percent at the start of the campaign, is now at the highest level in more than five years.
The Fed's stand-pat action means that commercial banks' prime lending rate, the benchmark for millions of consumer and business loans, will remain at 8.25 percent.
Tuesday's decision to pause came on a 9-1 vote of the Fed's interest-rate setting panel, with Jeffrey Lacker, president of the Fed's Richmond, Va., regional bank, dissenting.
It marked the first time since Fed Chairman Ben Bernanke took over from Alan Greenspan in February that a rate decision by the Federal Open Market Committee has not been unanimous.
The dissent gave a hint of the debate inside the committee between officials who feel the Fed's 17 consecutive rate increases will be enough to contain inflation and an opposing camp that points to worrisome signs of rising inflation in arguing that more rate hikes are needed.
Many private economists are betting that the Fed will raise rates one more time, probably at the next meeting on Sept. 20, pointing to language in the brief announcement that expressed worries that rising energy costs and tight labor markets posed a risk of higher inflation down the road.
"They are telling us they are pausing, but they are not promising to stay paused," said David Wyss, chief economist at Standard & Poor's in New York.
But other economists were not so sure about further rate increases. They noted elements in the statement that seemed to take an optimistic view that inflation would settle down, despite this week's worrisome jump in crude oil prices.
"Inflation pressures seem likely to moderate over time," the Fed stated, citing subdued inflation expectations and the fact that its earlier interest rate increases have not been fully absorbed by the economy.
Wall Street, where investors long have hoped for a pause by the Fed, posted a moderate decline on the news Tuesday, with the Dow Jones industrial average falling 45.79 points.
Some analysts said investors may be worried about the possibility of one or two more rate boosts, fearing that the central bank is close to overdoing the credit tightening and could run the risk of triggering a recession next year.
"A further rate increase at a time when 85 percent of the economy is slowing is just too dangerous," said Bernard Baumohl, executive director of the Economic Outlook Group.
U.S. industry also expressed relief with the Fed's decision.
"With sky-high energy prices already increasing the cost of doing business, the last thing manufacturers need is another interest rate hike," said David Huether, chief economist for the National Association of Manufacturers.
Already, the government has reported that overall economic growth slowed to a 2.5 percent annual rate in the spring, less than half the first quarter pace, and that job growth was anemic for the fourth straight month. The unemployment rate rose to 4.8 percent.
Bernanke, who raised hopes of a rate pause with his July congressional testimony, is counting on the economy to slow enough to bring inflation down to more acceptable levels.
That scenario could prove too optimistic, especially with soaring energy prices beginning to spill over into areas outside of energy.
The Fed dropped out a section of past statements which said strong productivity growth was keeping labor costs under control, apparently in recognition of a government report earlier in the day that showed productivity slowed dramatically in the spring and unit labor costs rose at the fastest pace since late 2004.
But many economists believe the Fed's basic forecast of slower growth, but no recession, and lower inflation rates has a good chance of coming true.
Mark Zandi, chief economist at Moody's Economy.com, said he believed the Fed will not need to raise rates again and by this time next year the Fed will start cutting rates because inflation will have slowed to acceptable levels.
"The Fed has tightened aggressively for two years and now they want to stop and assess the impact of those moves," he said.
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