Fed Bumps Up Interest Rate, More Increases Likely

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The Federal Reserve raised its short-term interest rate target to 3.75 percent Tuesday, but for the first time in more than two years the vote was not unanimous.

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Fed Governor Mark Olson was the only dissenting vote in raising interest rates by one-quarter percentage point for the 11th consecutive time. And in what the Wall Street Journal termed a “possible sign of unease,” just seven of the Fed's 12 regional reserve banks agreed to a quarter-point increase in rates.

Anthony Chan, economist at JP Morgan Asset Management, told MarketWatch that Fed Chairman Alan Greenspan might be suffering from "lameduck-itis," as he appears less able to sway a majority to follow his lead since his term ends at the end of January 2006.

The 3.75 percent rate applies to the federal funds rate, the rate that banks charge each other for overnight loans. The federal funds rate influences the prime rate that commercial banks use for consumer loans. The Fed also indicated that further increases were likely at a “measured” pace.

Tuesday's action will likely prompt commercial banks to increase their prime rate to 6.75 percent, the highest it's been in more than four years.

Some economists had speculated that the Fed might refrain from a rate increase due to Hurricane Katrina's potential impact on inflation, but the Fed maintained its pace of raising rates by one-quarter point each meeting since June 2004.

The central bank, in a statement, said that underlying inflation has been “relatively low,” and that expectations for longer-term inflation “remain contained.”

"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 Fed said, but added, "While these unfortunate developments have increased uncertainty about near-term economic performance, it is the Committee's view that they do not pose a more persistent threat."

Bill Dudley, chief U.S. economist at Goldman Sachs, told the Journal that the Fed may wish it had passed on raising rates this time. "There is a risk the energy shock is going to be bigger and have more damaging effects on the economy than realized.”

And economist Kathleen Camilli of Camilli Economics told USA Today that the energy shock “produces a high degree of uncertainty with regard to whether it will have an impact on consumer behavior and spending.”

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