Fed raises interest rates to 5-year high

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WASHINGTON (AP) – The Federal Reserve’s interest rate decisions may be getting less predictable.

After bumping up borrowing costs for the 16th time in a row on Wednesday, it left Wall Street and Main Street guessing what the next move, in June, might be.

Chairman Ben Bernanke and his Fed colleagues said they could raise rates again or they could take a break in their two-year rate-raising campaign.

Decisions on interest rates will hinge more heavily on what upcoming barometers say about economic activity and inflation, the Fed policymakers indicated.

If surging energy prices should spark broader inflation, the Fed could opt to bump up rates again. If the economy should show signs of slowing more than anticipated, a pause in rate raising could be in store.

To keep the economy and inflation on an even keel, the Fed unanimously decided on Wednesday to increase its federal funds rate by one-quarter percentage point to 5 percent. It marked the 16th increase of that size since the Fed began to tighten credit in June 2004.

The funds rate, the interest that banks charge each other on overnight loans, affects a variety of other interest rates charged to consumers and businesses and thus is the Fed’s primary tool for influencing economic activity.

In response, commercial banks raised their prime lending rate – for certain credit cards, home equity lines of credit and other loans – by a corresponding amount, to 8 percent.

The actions lifted both the funds rate and the prime rate to their highest points in just over five years.

Fed policymakers offered a largely positive assessment of the economic climate, although they continued to express concern about the potential for inflation to flare up.

Further moves “may yet be needed to address inflation risks,” they said. Any such action, they added, “will depend importantly on the evolution of the economic outlook as implied by incoming information.”

Economists said this language – more detailed than a previous policy statement issued on March 28 – gave the Fed more flexibility in terms of future interest-rate decisions.

On Wall Street, the Dow Jones industrials gained 2.88 points, while other stock indicators lost ground.

If the economy doesn’t slow to a more sustainable pace – as the Federal Reserve expects – and high energy prices start feeding into the prices of lots of other goods and service, then the Fed could opt to boost rates at its next meeting on June 28-29 or a some other point.

However, if economic growth does slow – something that could reduce inflation pressures – then the Fed might pause in its rate raising at the June meeting or perhaps later this summer.

Many economists believe the Fed will take a break in its rate-raising campaign this year – although they have mixed opinions on when that will happen. Some believe Wednesday’s increase will be the last for a while. Others predict the funds rate will rise to 5.25 percent in June and then the Fed will move to the sidelines. A few believe the rate will rise to 5.50 percent before a pause.

“We are now in much more uncertain territory. Monetary policy will become a lot less predictable and more focused on data,” said Lynn Reaser, chief economist at Bank of America’s Investment Strategies Group.

The economy in the first three months of this year grew at a brisk 4.8 percent pace, the fastest in 21/2 years. That is expected to slow to about 3 percent in the current April-to-June quarter, still a healthy pace.

One challenge facing the Fed is figuring out whether high energy prices will feed inflation, slow overall economic activity or perhaps lead to both scenarios. Another challenge is gauging the extent to which the housing market, which racked up record high sales five years in a row, will slow this year. A slowdown in the housing market is likely to crimp consumer spending and thus overall economic activity.

So far, the run-up in energy prices and other commodities has had only a modest effect on the prices of goods and services other than food and energy, the Fed said. Still, “elevated prices of energy and other commodities have the potential to add to inflation pressures,” the Fed added.

Oil prices hit a record high of $75.17 a barrel in late April; they are hovering above $72 a barrel currently. Gasoline prices have marched higher and have topped $3 a gallon in some areas.

Bernanke took over as chairman on Feb. 1. Of the 16 rate increases, Bernanke’s Fed ordered two and his predecessor, Alan Greenspan, 14. Before the increases, the funds rate had been sliced to a 46-year low of 1 percent to help the economy recover from the bursting of the stock market bubble, a recession and terror attacks.

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