Fed Hikes Key Interest Rate

Dolores Hope, the widow of legendary comedian Bob Hope, was joined by her dog Toro as she celebrated her 100th birthday in Los Angeles, on May 27, 2009. Hope died on Monday, Sept. 19, 2011 at the age of 102.
AP Photo/Chris Pizzello
The Federal Reserve on Tuesday boosted its overnight interest rate target to 1.5 percent from 1.25 percent, saying that higher oil prices had hurt the economy but that it appeared poised to resume a stronger pace of expansion.

The statement repeated that rate increases can proceed at a "measured" pace.

The vote was unanimous. The Fed also raised the discount rate to 2.5 percent on the recommendation of all 12 Fed banks.

There was no immediate consensus among Fed watchers about the tenor of the statement.

Many economists said the Federal Reserve had given itself the necessary wiggle room to hold rates steady in coming months if the economy continues to disappoint.

The change in the wording of the statement was "subtle enough to give them flexibility," said Irwin Kellner, chief economist for CBS MarketWatch.

But other economists viewed the statement as hawkish, signaling to the markets that quarter-point rate hikes will continue.

"All in all, the policy statement did not read like the FOMC envisions retreating to the sidelines at its next meeting [September 21], unless the current soft patch proves less temporary than anticipated," said Josh Shapiro, chief U.S. economist at MFR.

"This was a more hawkish tilt than some in the marketplace anticipated. August's employment report [September 3] will be a pivotal piece of data ahead of the next meeting," he added.

The Fed had kept interest rates at a 46-year low of 1 percent for about one year, beginning in summer 2003, out of concern about deflation, or falling prices.

But this year, rising oil prices have erased fears about deflation and Fed officials said it was time to move interest rates higher to avoid even higher prices.

They took the first step in June, boosting the overnight interest rate target to 1.25 percent, saying the economy was on solid footing.

Fed officials must have been surprised by the sudden weakness in the economy over the past two months. In particular, July nonfarm payroll employment rose by only 32,000 jobs, far below expectations and raising doubts about the strength of the economy.

In its statement, the Fed said that "output growth has moderated and the pace of improvement in labor market conditions has slowed."

It blamed the weakness on higher oil prices. "This softness likely owes importantly to the substantial rise in energy prices," the statement added.

But the remarks were upbeat about the economic outlook. "The economy nevertheless appears poised to resume a stronger pace of expansion going forward," the Fed said.

There was no change in the Federal Reserve's outlook on inflation over the last six weeks. They repeated their statement made in June that inflation has been "somewhat elevated this year, though a portion of the rise in prices seems to reflect transitory factors."

The federal funds rate is the rate banks charge each other for overnight loans to meet the Fed's reserve requirements. The Fed targets the rate by buying and selling Treasurys through its Open Market Desk.

Banks typically base their prime lending rates for their best customers on the federal funds rate. Other lending rates in the economy, including home mortgages, credit card rates and commercial paper rates, are based on market forces and are influenced over time by the Fed's actions.