Interest rates by half point: Analysts uncertain about future increases

Wednesday, May 17th 2000, 12:00 am
By: News On 6

WASHINGTON - Now, there is only the uncertainty.

The Federal Reserve Board raised short-term interest rates half a percentage point Tuesday - just as most market analysts expected. But Fed Chairman Alan Greenspan and his fellow policy-makers left questions about what comes next.

One or two additional rate increases might come before the Nov. 7 election, some experts said. Others suggested that the Fed might be finished for the year.

If interest rates do go up, the boost might be a quarter or half point or maybe even a full percentage point.

Or maybe not at all.

But analysts said the uncertainty could produce a good outcome. The Fed wants to fight inflation, and doubts about future interest rate policy could keep the stock market from overheating - thus reining in America's free-spending consumers.

"Without a significant, sustained correction in the stock market I do not see how we can have a slowdown in consumer spending and economic growth," said Sung Won Sohn, chief economist at Wells Fargo Bank in Minneapolis.

Consumers and businesses are about to find it a bit more expensive to borrow money. The Fed's move, its sixth increase in key short-term rates since last June, set off a chain reaction as banks ratcheted up their interest charges to reflect their new costs.

As higher lending rates take effect, the Fed hopes the economy will cool off and minimize a surge in prices.

Martin Cox, president of Chase Bank of Texas in Dallas, said the Fed's increases have dampened the demand for bank loans. The economy in Dallas remains strong, he said, but the Fed's policies may have helped prevent business owners from expanding too rapidly or taking excessive risks.

"These Fed actions have sent the right message," Mr. Cox said. "The fact that interest rates have gone up, and it could go up a little more, has put the brakes on psychologically a little bit."

Tuesday's action put the federal funds rate at 6.5 percent - an increase of half a percentage point hike, the biggest in five years. The federal funds rate, the interest fee banks charge one another on overnight loans, is at a nine-year high.

In raising rates, the Fed signaled that higher inflation remains a threat. But the central bank stopped short of hinting when or how much it would raise interest rates again. Fed policy-makers next meet June 28.

In a prepared statement, the Federal Open Market Committee said it remained "concerned that this disparity in the growth of demand and potential supply will continue, which could foster inflationary imbalances."

As a largely symbolic gesture of its intentions, the central bank also raised its discount rate half a percentage point to 6 percent. The discount rate is the lending fee that Federal Reserve Banks charge on loans to member banks. It has less effect on market rates than the federal funds rate.

Within minutes of the Fed's decision, Bank of America and Bank One led the nation's commercial banks in announcing they would boost their prime lending rates a similar half point. The banks raised the rate, which is used to determine other lending fees, from 9 percent to 9.5 percent, also the highest level in nine years.

While economists talked about uncertainty, some brokers brimmed with hope that the Fed's work was almost finished.
"There are a lot of people on Wall Street thinking we are near the end," said Phil White, who manages the Plano branch office of Prudential Securities.

Major stock indexes retreated only briefly when the Fed announced its decision, then finished ahead for the day. The Dow Jones industrial average closed up 126.79 at 10,934.57.

Abby Joseph Cohen, a managing director at Goldman Sachs & Co., told a Washington audience that she expects stocks to continue rising this year.

"We expect gains of a low dougle-digit nature," she said, and dismissed others' worries of resurgent inflation and of an overvalued stock market.

Recent government reports on inflation are still reflecting the effect of last winter's jump in energy prices, she said. Though core inflation is rising somewhat, she said, it remains low and is offset by consumer resistance to price increases.

Raising interest rates half a percent was a departure from the Fed's previous strategy of quarter-point increases. Analysts said the central bank was compelled to make a bolder inflating-fighting move, because previous increases have failed to slow growth.

Bruce Steinberg, chief economist at Merrill Lynch & Co. in New York, said there are some signs that consumer spending is moderating, but not sufficiently to satisfy the Fed.

"We will have to see further evidence that the economy is moderating and that labor growth does not continue to tighten," said Mr. Steinberg, who predicted a quarter-point increase from the Fed in June.

The Labor Department reported Tuesday morning that consumer prices held steady during April. But analysts said it will take more than a one-month moderation in the Consumer Price Index to signal that prices are under control.

And there are other worrisome signs.

The unemployment rate dipped to a 30-year low of 3.9 percent in April, and consumers have continued to purchase new homes, autos and durable goods. Moreover, the Employment Cost Index, which tracks inflation pressures in labor costs, rose 1.4 percent during the first quarter. That marked its biggest gain in more than 10 years.

Mr. Cox, the Dallas banker, said his customers are feeling the pressure from a worker shortage. He said many employers are raising wages to fill open positions, although higher labor costs have not hurt their financial performance so far.

"They are operating with fewer people and paying more," Mr. Cox said, "and higher productivity and technology have a allowed a lot of these businesses to operate more efficiently and more cheaply."

Staff writer Jim Landers contributed to this report.