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. Last Updated: 07/27/2016

Another Interest Rate Hike Forecast

WASHINGTON -- Once won't be enough in the Federal Reserve's effort to crush bubbling inflation pressures with higher interest rates, many economists believe.


Saying the economy's strength risks fueling inflation, the central bank raised a key short-term interest rate by a quarter of a percentage point to 5.5 percent Tuesday. "This action was taken in light of persisting strength in demand, which is progressively increasing the risk of inflationary imbalances developing," the Fed said.


Citibank, the nation's No. 2 bank, and other lenders followed by raising their prime rate -- a benchmark for millions of consumer and business loans -- from 8.25 percent to 8.5 percent. More expensive auto loans, adjustable-rate mortgages and credit-card borrowing will result.


The stock market, which had been well-prepared by Fed Chairman Alan Greenspan's public comments, reacted mildly. The Dow Jones average fell 29.08 to close at 6,876.17, only partly giving up a 100-point gain from the day before.


The reaction was more pronounced on the bond market, where worries about more rate increases down the road sent prices down and the yield on Treasury's 30-year bond up to 6.97 percent.


Most analysts believe the increase in the federal funds rate charged on interbank loans -- the first in two years -- will be followed by additional increases. The Fed almost never moves just once, they said.


"There's a good chance they'll have to raise rates at least once or maybe two more times by this summer," said economist Mark Zandi of Regional Financial Associates in West Chester, Pennsylvania. "The economy is very strong and one rate hike isn't going to do much to dampen it."


Chances are about 50-50 the next quarter-point increase will come at the Fed policy-makers' May 20 meeting, Zandi said. And, if not, an increase is a stronger possibility at the July 1 and 2 gathering, he said.


Economist Stephen Roach of Morgan Stanley and Co. predicted short-term rates will be a full percentage point higher by the end of the year. That will roil the stock and bond markets, which aren't expecting that much, he said.


"Markets typically underestimate the extent of monetary tightening," he said. "There's a real reluctance on the part of investors to believe there's more in the pipeline."


However, a few analysts believe the economy already is slowing and what the Fed termed "a slight firming of monetary conditions" will be enough to prevent inflation from worsening.


"That's their last action for quite a long time, probably for the rest of the year," said Bruce Steinberg of Merrill Lynch. "I don't think there's another tightening in the wind."


In the Fed's last round of tightening, from February 1994 to February 1995, it raised interest rates seven times, doubling the federal funds rate from 3 percent to 6 percent.


But, Steinberg said, this time will be different because inflationary pressures were stronger then and the central bank was starting with a federal funds rate at a 20-year low.


Indeed, inflation so far this year is better -- not worse -- than last year. The Labor Department's Consumer Price Index rose at a 2.3 percent annual rate in January and February, compared with 3.3 percent for all of last year.


In its statement, the Fed said a small dose of higher interest rates to take the edge off inflation will increase the chances of sustaining the economic expansion through its seventh year. "The experience of the last several years has reinforced the conviction that low inflation is essential to realizing the economy's fullest growth potential," it said.


While many economists laud this pre-emptive approach to squelching inflation, it's less popular with politicians.


Representative Jim Saxton, a Republican who is chairman of the Joint Economic Committee, said, "Hopefully, this will be all that is undertaken."


Senator Paul Sarbanes, the senior Democrat on the Senate Banking Committee, said it was "a mistake for the Federal Reserve to deprive the country of the important human benefits of sustained economic growth with an unnecessary increase in interest rates."


Added President John Sweeney of the AFL-CIO labor federation: "The Federal Reserve has sacrificed the economic interests of America's working families on the basis of a hunch."