Washington, DC, June 30--The Federal Reserve raised its key short-term interest rate for the first time in four years today, kicking off what it said is likely to be a "measured" campaign to return the rate to a level appropriate for a healthy economy.
The central bank's monetary-policy committee voted unanimously to raise the federal funds rate by a quarter percentage point to 1.25%. The move marked a shift away from an era of exceptionally cheap credit that fueled a house purchasing boom and inoculated the U.S. economy against terrorist threats and a wave of corporate accounting scandals.
"Output is continuing to expand at a solid pace and labor-market conditions have improved," the Federal Open Market Committee said. That has fanned some inflation, although "a portion of the increase in recent months appears to have been due to transitory factors," it said.
Under the circumstances, the panel said, the central bank doesn't need to rapidly reverse the economic stimulus from low interest rates it has provided since 2001. Policy makers, it said, believe "policy accommodation can be removed at a pace that is likely to be measured."
But they added a caveat to ensure they have the freedom to raise interest rates in larger increments if necessary: "Nonetheless, the committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability."
In a related move, the central bank opted to raise the largely symbolic discount rate by a quarter percentage point to 2.25%. The increase was approved unanimously by the Fed's board of governors.
The decision to raise interest rates was widely expected on Wall Street: all 23 of the primary bond dealers authorized to trade securities with the Fed saw it coming. It is likely, accordingly, to have little effect on fixed mortgage rates, which moved up over the last few months in anticipation of a higher federal funds rate.
Still, analysts fear some businesses and credit-card users could face an uncertain outlook now that interest rates are set to climb rather than fall.
Wall Street expects the FOMC to raise the funds rate by a quarter percentage point at each of its next four meetings, which would leave the rate at 2.25% by year's end. The increases are likely to persist through the end of 2005, by which time the rate could be as high as 4.5%, said Josh Feinman, an economist with Deutsche Asset Management in New York.
Economists say such increases could sting Americans with adjustable-rate mortgages and floating interest rates on consumer loans, but the overall economy is likely to take them in stride. "Right now the economy is awash in money -- there's no liquidity issue at this time, and there isn't likely to be for some time," said Bob Walters, chief economist with Quicken Loans in Livonia, Mich.
Over the last three-and-a-half years, the Fed cut the funds rate faster than at any previous time in its history. Amid a series of economic setbacks the rate dropped to its lowest level since the late 1950s. Even after the economy started to grow rapidly last year, the Fed chose to keep the rate low because it thought the job market hadn't recovered.
This year, however, the U.S. economic rebound became a recovery at full throttle. Employers added nearly a million non-farm jobs from January through May. Wall Street economists predict that by the end of the year, employers will have restored nearly all of the 2.7 million jobs cut between 2001 and 2003. Consumer confidence, as a result, is high and business capital expenditures are rising.
That has obligated the Fed to shift gears. To make sure inflation stays under control, Fed policymakers say they want to return the federal funds rate to a "neutral" level that neither stimulates nor constrains the economy. That level has varied sharply over the years -- from slightly less than 3% to nearly 5% -- so Fed policymakers say they intend to proceed
