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Fed raises rates, more hikes seen likely
Updated: 2004-08-11 09:15

The U.S. Federal Reserve on Tuesday raised interest rates another quarter of a percentage point to head off potential inflation, saying the economy had been hit by energy costs but was poised for faster growth.

The unanimous decision by the policy-setting Federal Open Market Committee moves the benchmark federal funds rate, charged on overnight loans between banks, to 1.5 percent.

In announcing its second rate rise this year, the central bank gave no sign it was prepared to let up on a "measured" campaign to lift the fed funds rate to a more neutral level despite weak July jobs data.

It raised rates by a quarter point after its last meeting on June 30 -- the first increase in four years.

"In recent months, output growth has moderated and the pace of improvement in labor market conditions has slowed. This softness likely owes importantly to the substantial rise in energy prices," the Fed said.

"The economy nevertheless appears poised to resume a stronger pace of expansion going forward," it added.

The statement repeated that with inflation expected to be relatively modest, "policy accommodation can be removed at a pace that is likely to be measured."

Investors honed in on the Fed's optimistic tone, with the dollar and stock markets rallying. Bond prices eased in anticipation of more interest-rate rises.


Financial markets saw a rising likelihood of more rate hikes as early as the next FOMC meeting on Sept. 21 in light of the Fed's reassurances, although incoming data, including August job figures out Sept. 3, could change that picture.

A poll by Reuters after Tuesday's rate move found a significant shift from just days ago in the number of firms that anticipate a further borrowing cost increase next month.

Some 14 out of 19 of Wall Street's top firms surveyed predicted another quarter percentage point rise in September, up from 10 in Reuters' previous poll on Friday.

Economist Greg Valliere of Schwab Washington Research Group said the Fed statement seemed designed to underline its confidence in the economy and its wish to soothe consumers who might have been shaken by soft jobs data in July.

"This was their way of saying that we're not falling off a cliff, that the economy is still sound," Valliere said. "The Fed has not given up its belief that growth will rebound."

Similarly, New York-based economist Ram Bhagavatula of the Royal Bank of Scotland said policy-makers seemed to have decided a second-quarter economic hiccup was not serious.

"So they're not indicating that they're going to take any holiday from the tightening process," he added.

Fed policy-makers explicitly acknowledged the drag on the U.S. economy from energy prices, which have been pushed to record levels by strong demand for oil from economies like China and concerns about supply in the Middle East and Russia.

Some analysts expressed reservations about the Fed's buoyant assessment of growth prospects, especially given that it is not clear what will cause energy prices to fall or at least stabilize.

"I'm not 100 percent convinced by their optimism given that energy prices are remaining strong but that's what they're saying," said economist David Sloan of 4Cast Ltd.

The central bank said economic risks remained balanced between weaker growth and higher prices, repeating that some of the recent signs of inflation pressure appeared to stem from transitory factors.

They also retained a pledge to respond to changes in the economy as needed to keep inflation under wraps -- wording some in financial markets thought might shift to reflect more concern about employment.


Last month, Fed Chairman Alan Greenspan said while the pace of the expansion clearly faltered in June, he did not foresee a lengthy slowdown.

"It is nonetheless the case that the little bulge in inflationary pressures seems to have created a soft patch here and it is something obviously we are watching very closely," he said.

High energy prices have turned consumers thrifty and taken a toll on economic growth, with U.S. gross domestic product expanding at a 3 percent annual rate in the second quarter after advancing at a 4.5 percent clip in the first.

Last week's news that just 32,000 payroll jobs were created in July came as a shock to markets. It raised questions about how long weakness would last and led some economists to question whether the Fed should be increasing rates.

Campaign advisers for President Bush and Democratic rival John Kerry are likely to comb through the Fed's take on the economic future, which has been a top voter concern heading into November's presidential elections.

Bush credits his tax cuts with helping the economy turn the corner to a stronger expansion after a recession and halting recovery. Kerry argues the administration's policies have not only failed to stimulate solid hiring but have fueled record budget deficits.

The Fed also raised the more symbolic discount rate, which it charges on infrequent loans to member Fed banks, a quarter-point to 2.5 percent.

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