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Interest-rate rise signals end of easy-money era

By Michael Oneal
Chicago Tribune

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The nation's central bank — as expected — raised its key federal-funds rate a quarter point to 1.25 percent yesterday.

The increase was the first in four years and signaled the end of an easy-money era that saw rates plunge to a 46-year low of 1 percent.

In comments with a news release announcing the increase, Federal Reserve officials, led by Chairman Alan Greenspan, said the move will begin a stairstep increase in rates that will likely be "measured" in nature.

But the officials made no promises of gradualism. In a departure from their last announcement after a meeting in May, Fed officials also reserved the right to raise rates higher and faster if the bubbling economy turns up the heat on inflation. The Fed's next meeting is Aug. 10.

"The Committee will respond to economic prospects as needed to fulfill its obligation to maintain price stability," the statement said.

The rate increase was hardly a surprise. In an attempt to avoid the shocks that led to Wall Street turmoil during a rate-increase cycle in 1994, Greenspan and other Fed officials have for months signaled their intent to tighten the spigot on cheap financing.

So far, the strategy seems to be working. Long-term interest rates on bonds and mortgages have risen steadily since March in anticipation of the move. And financial markets responded favorably, if somewhat tentatively, to yesterday's announcement. Several large banks quickly raised their prime lending rates to 4.25 percent from 4 percent.

Right now, said Mark Zandi, chief economist of Economy.com, "Greenspan's got the economy and the markets right where he wants them."

The question is whether he can keep them there.

Coupled with the Bush administration's tax breaks, easy financing for everything from cars to homes has fueled a consumer spending spree that has been the pillar of the economic recovery.
 
Having decided the economy is strong enough to stand on its own, the Fed has turned to the delicate matter of maintaining growth while keeping inflation in check, economists said.

Many economists expect the Fed to keep increasing the funds rate until it hits around 4 percent. At that level, analysts said, the Fed would view the rate as neither stimulating extra growth nor acting as a drag on the economy.

The rate increases are expected to have little impact in slowing the economy before the November election. That would be good news for President Bush and other incumbents.

Bush's spokesman, Scott McClellan, told reporters that rising rates were not a concern because interest rates are still at "historically low levels. The economy continues to be strong and grow even stronger."

Gene Sperling, an economic adviser to Bush's presumed Democratic rival, John Kerry, said the real threat to rates was not Fed action but Bush's tax cuts, which have caused the budget deficit to balloon.

"The real issue is that George Bush's abandonment of fiscal discipline will mean higher long-term interest rates, less sustainable economic growth and more debt passed on to our children," Sperling said in a statement issued by the Kerry campaign.

Already, soaring prices of products like fuel have raised red flags. And some economists worry record-low mortgage rates have driven home prices to outpace income growth — possibly creating a housing bubble some places..

At the same time, the economy continues with puzzling signs. While the U.S. has added more than 1 million jobs in the past few months, wages are rising slowly.

Corporate profits and consumer-confidence measures are soaring, but the nation's output in the first quarter was slower than originally thought, and orders for durable goods like autos and capital equipment have weakened.

This week, Wal-Mart, Target and General Motors all said they were expecting sales were weaker in June. Like most economists, Drew Matus of Lehman Brothers in New York remains confident the economy is on strong footing. But given all the mixed signals, he said, "I don't know anybody who would bet their life on their forecast right now."

That makes Greenspan's attempt to raise rates fast enough to slay inflation without sparking an economic slowdown especially difficult.

The Fed decision means savers will earn more on their bank accounts, and debtors will pay more interest on their credit cards and home-equity lines of credit.

But not a lot, at least in the short term. "We're not talking about drastic action here," said Gary Thayer, chief economist at A.G. Edwards & Sons in St. Louis. "We're talking about small, incremental changes."

Savers are among the most eager for higher rates; their accounts have been earning 1 percent or less in interest in recent years.

Edward Cunningham, a retired corporate-finance officer living in Madison, Wis., said the low rates were "terrific if you wanted to take out a mortgage ... but punishing if you were a saver."

Cunningham, 83, said that he and his wife, Louise, 82, live on Social Security, a pension and investments but keep a savings account to draw on for travel, special purchases or emergencies.

He said he found an online money-market account that pays 2 percent and expects the rate "to go up a little, but not much" after the Fed's move.

The fact is, a quarter of a percentage-point increase in interest translates to just $2.50 per $1,000 in savings per year.

At the same time, consumers who borrow money will have to pay more for the privilege.

The place Americans will most feel the increases is on credit-card debt, which currently totals $750 billion, Fed data show.

About half of the credit cards in the country have variable rates, which "will go up in tandem with the prime rate, which is driven by what the Fed does," said Robert McKinley, chief executive of CardWeb.com in Frederick, Md., which publishes data on credit and debit cards.

Cardholders could see the higher rates as early as this month, he said.

Information from The Associated Press is included in this report.