Fed raises rates to 3.75%
Katrina poses no persistent threat to growth
By Greg Robb & Rex Nutting, MarketWatch
Last Update: 2:18 PM ET Sept. 20, 2005
WASHINGTON (MarketWatch) - The Federal Reserve raised interest rates again Tuesday, saying Hurricane Katrina could fuel inflationary pressures but does not pose a persistent threat to the U.S. economy.
The 9-1 vote to increase the federal funds target rate by a quarter percentage point to 3.75% leaves the key interest rate at its highest level since June 2001.
"The widespread devastation in the Gulf region, the associated dislocation of economic activity and the boost to energy prices imply that spending, production and employment will be set back in the near term," the committee said.
"Higher energy and other costs have the potential to add to inflation pressures," the committee said. However, core inflation was low and longer-term inflationary pressures were contained.
Gov. Mark Olson dissented at the meeting, voting to hold rates steady.
Markets expect one or two more rate hikes from the Fed before the end of the year, but the FOMC gave no indication that it's done. The committee said current rates remain "accommodative" and suggested again that rates could be raised at a "measured" pace.
Despite pleas to wait and see what impact the most devastating storm in U.S. history would have on growth and inflation, policymakers concluded that a rate hike could not wait, lest inflationary pressures grow.
Markets were expecting the Fed to hike rates. See full story.
The Fed will release a summary of Tuesday's meeting on Oct. 11.
Fed chief Alan Greenspan is scheduled to discuss the economic outlook in a speech to the annual meeting of the National Association of Business Economics in Chicago on Sept. 27.
Prior to the FOMC meeting, the futures market expected the Fed to hike rates at its meeting on Nov. 1 but pause at its last meeting of the year on Dec. 13, leaving the federal funds rate at 4% at year-end..
The FOMC has raised rates 11 times since June 2004 in an effort to bring the fed funds rate to a more neutral level - that is, a level where rates are not triggering inflation or slowing growth.
The federal funds rate is the rate banks charge each other for overnight loans to comply with the Fed's reserve requirements. By buying or selling Treasurys in the market, the Fed can set the interest rate and influence the price of credit.
Longer-term interest rates are not under the direct control of the Fed.
The Fed had kept interest rates at 40-year low level of 1.0% from mid-2003 to mid-2004 to ward off potential deflation. But since then, the Fed has been worried that low interest rates could trigger higher inflation as the economy returned to a more normal healthy growth environment.
Before Katrina, the Fed had been fairly successful, with growth consistently around a healthy 3.5% clip and inflation remaining low.
But since Katrina stuck the Gulf Coast region on Aug. 29, all sure bets about the future performance of the economy are off.
At first economists were worried that the economy could seize up if gasoline from refineries along the Gulf of Mexico could not reach consumers.
But the blow to the critical energy sector has not been as bad as first feared.
Many economists now view inflation from high gasoline prices and construction materials to be the biggest threat from Katrina. Many of these same economists are worried that the massive federal spending to rebuild the region could also lead to higher prices.
But other economists are still worried that Katrina could lead to an economic recession as consumers curtail spending to pay for gasoline and natural gas to heat their homes, and as businesses follow suit and stop hiring new workers.
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