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The Federal Reserve, caught between a sudden economic slowdown and heightened worries about inflation, decided to nudge a key interest rate up by another quarter-point on Tuesday (May 3).
The Associated Press reported that the move, which had been widely expected by financial markets, pushed the federal funds rate up to 3%. It was the eighth increase in the interest that banks charge each other on overnight loans since the central bank began its credit tightening campaign last June.
The Fed also retained a promise it has been making for the past year to move rates up “at a pace that is likely to be measured,” a phrase that markets have interpreted as signaling continued small quarter-point rate increases.
The increase in the funds rate was expected to trigger a corresponding quarter-point increase to 6% in banks’ prime lending rate, the benchmark for millions of business and consumer loans, including the recreational vehicle industry.
The decision by Federal Reserve Chairman Alan Greenspan and his colleagues came as the central bank is being buffeted by strong economic crosscurrents – rising inflation pressures on one hand and a sudden slowing in economic growth on the other.
Noting the recent slowdown, the Fed in its statement said, “Recent data suggest that the solid pace of spending growth has slowed somewhat, partly in response to the earlier increases in energy prices.”
The Fed also noted rising prices, saying “pressures on inflation have picked up in recent months and pricing power is more evident.” However, toward the close of Tuesday’s trading, the Fed revised its statement, adding that inflation expectations “remain well-contained.”
It was widely expected that faced with those conflicting forces, the Fed would stay the course, raising interest rates marginally in an effort to keep inflation pressures from this year’s spurt in oil prices from spilling into other sectors of the economy.
When the Fed started boosting rates 10 months ago, the funds rate stood at 1%, the lowest level in 46 years.
Many economists believe the Fed will keep raising the funds rate for the rest of the year with more quarter-point moves until it reaches a “neutral” point for the funds rate, the level where the rate is neither stimulating economic growth or depressing growth.