As Expected, Fed Raises Rate One Quarter Point

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The Federal Reserve's interest-rate setting Federal Open Market Committee raised the federal funds rate one quarter point to 4 percent Tuesday, the twelfth consecutive increase since June 2004. In a statement announcing the increase, the Fed cited “robust underlying growth in productivity” and “economic activity that will likely be augmented by planned rebuilding in the hurricane affected areas,” as motivators for the change, the Associated Press reports. The statement added, “The cumulative rise in energy and other costs have the potential to add to the inflation pressures.”

Banks were expected to raise the prime rate a quarter-point to 7 percent.

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Consumers are less optimistic than the Fed about the U.S. economy. The sharp increase in gasoline prices since Hurricane Katrina brought the Conference Board consumer sentiment index to a two-year low in September. Personal income growth of 1.7 percent for the month, adjusted for one-time insurance payouts related to the hurricanes, hovered around .5 percent, according to the Wall Street Journal.

Although energy costs have yet to affect core inflation, the core level is approaching 2 percent, Reuters reported, and statements by Federal Reserve governors in recent weeks suggest that additional increases in the federal funds rate may be needed.

“We are considerably closer to where policy needs to be than we were 16 months ago, but we are not yet at a point where we can stop and watch the economy evolve for a while,” Fed governor Donald Kohn said on October 19.

Tuesday's statement from the Fed retained language it has been using, saying it believes future interest rates can occur "at a pace that is likely to be measured", the AP reports.

Some economists think the rate increases are nearing an end. Earlier concerns about possibility of an inverted rate curve where short term rates exceed long-term rates,– termed “a conundrum” by Alan Greenspan -- have eased. The 10-year treasury is now above 4.5 percent. The increase in the long-term rate affects mortgages and can bring about a gradual cooling in the housing market, according to a report in CNNMoney.

While the Federal Reserve has been increasing short-term rates, central banks in Europe and Japan have kept their rates steady, helping to strengthen the dollar and make dollar-denominated investment more attractive to foreign investors, CNNMoney reports.

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