Fed bumps up interest rates

(August 10, 2004) In a move widely anticipated by economists, the U.S. Federal Reserve today raised its key overnight lending rate 25 basis points to 1.5%. The Fed also signalled that it will likely continue to boost interest rates at a measured pace.

“The committee believes that, even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity,” the Fed said in a statement accompanying today’s decision.

The Fed also noted that although economic growth has moderated in recent months and that the previously rising trend in jobs has slowed slightly, that’s likely due mostly to higher energy prices. “The economy nevertheless appears poised to resume a stronger pace of expansion going forward.”

This decision marks the second phase of the Fed’s tightening campaign: U.S. rates rose to 1.25% from 1% on June 30. With inflation expected to remain in check, the Fed said it can continue to boost rates at a measured pace, a scenario analysts expect to see over the next couple of years.

“The end result could be a fed funds target rate of 4% by the end of 2005,” predicts David Watt, senior economist at BMO Nesbitt Burns.

Watt admits that higher rates will naturally lead to concerns about the impact on the U.S. consumer. But he says as long as the Fed does not fall too far behind the inflation curve, “neither consumers nor businesses should be too perturbed by higher rates.

“In fact, given that the U.S. should emerge from its ‘soft patch,’ a bigger risk to the financial health of the economy would be to further delay the process of raising rates.”

Last month, the Bank of Canada left its key overnight lending rate unchanged at 2%. The Canadian central bank’s next interest rate announcement is set for September 8.

Filed by Doug Watt, Advisor.ca, doug.watt@advisor.rogers.com