Fed Raises Interest Rates to 2.25 Percent

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The Federal Reserve on Tuesday raised interest rates for the fifth time since June and signaled it was likely to keep pushing them higher at a "measured" pace in the new year.

The latest quarter-point increase raised the federal funds rate, the interest that banks charge each other, to 2.25 percent, more than double the 46-year low of 1 percent in effect when the Fed kicked off its credit-tightening campaign six months ago.

The increases have been designed to back off slowly from the exceptionally low interest rates the central bank had put in place over the previous three years as it battled a bursting stock market bubble, a recession and the Sept. 11 terrorist attacks.

Responding to the latest increase, commercial banks quickly moved to boost their prime lending rate, the benchmark for millions of consumer loans and business loans, by a quarter-point to 5.25 percent.

The Fed's action — and comments — bolstered confidence on Wall Street and pushed stock prices higher.

Economists give Federal Reserve Chairman Alan Greenspan and his colleagues high marks for navigating the tricky transition away from an extremely easy money policy that had been in effect for an extended period without causing the financial upheavals that have happened in the past.

Greenspan joked recently that "rising interest rates have been advertised for so long and in so many places that anyone who hasn't appropriately hedged his position by now obviously is desirous of losing money."

In its latest action, the Fed repeated its pledge that with inflation pressures remaining low, the central bank should be able to keep raising rates at a "measured" pace.

That could translate into further quarter-point rate hikes through the first half of next year until the central bank decides it has reached a "neutral" level for monetary policy in which rates are neither stimulating economic growth nor acting as a drag on growth.

Many analysts believe that point is probably around 3.5 percent.

Some believe the quarter-point rate increases will keep coming until the fifth meeting of 2005 next August. However, others said the Fed may be getting closer to a pause in which policy-makers will assess the impact the rate hikes so far are having before deciding to go further.

"I think the Fed is quite happy with current economic circumstances," said economist David Jones, author of four books on the Greenspan Fed.

In describing current conditions, the Fed statement said, "Output appears to be growing at a moderate pace despite the earlier rise in energy prices, and labor market conditions continue to improve gradually. Inflation and long-term inflation expectations remain well contained."

At its last rate hike on Nov. 10, the Fed had stated that labor market conditions "continue to improve," a reflection of the 300,000-plus jump in payroll employment that had been reported for October. However, with job growth slowing to just 112,000 in the latest report, Fed officials apparently felt the need to use the word "gradually" to describe the labor market improvement.

The Fed kept its assessment of future risks unchanged, saying that the chances of economic growth coming in lower than expected or inflation rising at a faster pace were balanced.

The Fed is expected to keep the "balance of risks" part of its statement at neutral until it embarks on the second stage of its credit tightening campaign, when it begins moving from a neutral funds rate to one that is aimed at actually slowing economic growth to keep rising inflation pressures from getting out of hand.

"The current target of the central bank is to reach the neutral rate ... sometime later in 2005," said Sung Won Sohn, chief economist at Wells Fargo in Minneapolis. "However, the speed of the rate hikes will depend on future economic data."