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. Last Updated: 07/27/2016

Tiny Rise Shows Fed Confidence in Economy

WASHINGTON -- The Federal Reserve has nudged up a key interest rate, suggesting that the U.S. central bank thinks the national economy needs a little f but only a very little f extra protection against inflation.

The decision Tuesday was widely anticipated and appears to put the Fed firmly in the camp of those who believe the U.S. economy can go right on growing even with wages rising and qualified workers increasingly hard to find.

The Fed coupled its quarter-point hike in the federal funds rate with a decision to maintain its wait-and-see attitude toward future increases. It issued a bullish statement saying its actions "should markedly diminish the risk of rising inflation going forward.''

"They think the run of growth without inflation we've had is more than a lucky break,'' said Peter Kretzmer, a senior economist with Bank of America Corp. in New York. "They hope that by tweaking these rates they can extend the run for some time to come.''

The central bank increased the federal funds rate, the rate at which banks make short-term loans to each other, from 5 percent to 5.25 percent.

In response, three major banks f Bank One Corp., First Union and Wells Fargo Bank f raised their prime lending rate by a quarter point, to 8.25 percent, immediately after the Fed acted.

While the Fed's increase was intended to slow economic activity by raising the borrowing costs of everybody from corporate executives to home buyers, analysts said much of the adjustment has already occurred.

Rates on a 30-year mortgage, for example, have risen more than a percentage point so far this year to about 8 percent, knocking new home loan applications off their record highs, according to Freddie Mac, the quasi-public mortgage corporation.

"This is not going to make a big difference,'' said Peter D'Antonio, an economist with New York-based Salomon Smith Barney. Fed policy-makers "are trying not to squash the economy, just temper it,'' he said.

Financial market reaction was mixed after the Dow Jones Industrial Average had surged 199 points Monday. The Dow finished Tuesday off 16.26 points, or 0.1 percent, at 11,283.30.

Bond yields continued to slide from what had been 22-month highs as recently as two weeks ago. Tuesday's action was the latest loop in the roller-coaster ride that began earlier this year when Fed chairman Alan Greenspan said that the nation's labor markets were growing so tight they could send wages and then prices spiraling upward. He warned that the central bank was ready to prevent that by raising interest rates to slow the economy. In fact, the Fed did raise the federal funds rate a quarter point on June 30. But it coupled the increase with a decision to remove its tilt in favor of further rate hikes, a move that was widely taken as signaling that no further increases were on the way.

What's most remarkable about the Fed's latest decision is its modesty in the face of some of the very trends that Greenspan and others had said would provoke decisive action. The most striking are those involving wages and benefits.

In recent weeks, the government has said that its broadest measure of labor costs, the employment cost index, climbed 1.1 percent in the three months from April through June, triple its rate from January through March. Average hourly earnings rose 0.5 percent in July, their biggest monthly jump since the start of the year.

Analysts said the Fed took only restrained action because there is little evidence that price increases are coming on the heels of the wage hikes. And price increases are the Fed's biggest worry.

"The latest inflation data is utterly fantastic,'' said Brian Wesbury, chief economist with Griffin, Kubik, Stephens & Thompson, a Chicago investment bank. Consumer goods rose a mere 0.3 percent in July.

Beyond such immediate evidence, the Fed also appears to be banking on a continuation of the yet-to-be-understood forces that have let the nation enjoy longer, stronger growth with lower unemployment and inflation than most economists had believed possible. The current expansion will break the record for the longest in history if it lasts until the early months of next year.

The central bank's move still leaves the fed funds rate a quarter point below its 5.5 percent level of a year ago, before the central bank slashed rates three times beginning in September. That was to cope with a panic on financial markets in the wake of Russia's debt default and a string of currency crises that reached as close to home as Brazil.

Besides raising the fed funds rate, the central bank also raised the discount rate, which the Fed charges when lending to banks, from 4.5 percent to 4.75 percent. Analysts said that move had little economic significance because banks rarely borrow directly from the Fed for fear of appearing financially weak.