WASHINGTON (MarketWatch) - At Alan Greenspan's final meeting, the Federal Open Market Committee voted unanimously to raise the benchmark federal funds target rate by a quarter-percentage point to 4.50%, putting rates at their highest level since mid-May 2001.
The committee signaled further rate hikes could come to keep inflation at bay.
The FOMC said inflation was low and inflation expectations remained contained. However, slack in the economy was disappearing, and could add to inflationary pressures, the committee said.
In its statement, the committee removed language that suggested further rate hikes would be measured. The committee also said further increases "may be needed," a change from wording in December that said further increases would "likely" be needed.
It was a dramatic day for the central bank. The Senate was poised to confirm Ben Bernanke, the White House's chief economic adviser, to replace Greenspan as chairman of the Federal Reserve. Bernanke will assume the post Wednesday and will lead the March 28 meeting of the FOMC.
The increase in the fed funds rate was expected. Economists believed the FOMC would soften its language to give Bernanke all of the freedom he needs to put his own stamp on monetary policy. See full story.
Financial markets expect the Bernanke Fed to boost rates at least one time before the committee stops.
Tuesday's rate hike is part of the Fed's slow and steady tightening from a four-decade low funds rate of 1% reached in June 2003. The Fed took rates down so low to ward off a potential outbreak of deflation, a potential disastrous fall in prices.
Since June 2004, the committee has been raising rates steadily in an effort to bring the federal funds rate to a more neutral level -- that is, where rates are neither stimulating nor slowing growth.
The FOMC has been battling to keep core inflation within a comfort zone of about 1% to 2%. In the past year, core inflation has increased 1.9%, but the recent trend has seen inflation heat up to a 2.2% pace.
Meanwhile, growth dropped sharply in the fourth quarter to 1.1%, the slowest in three years. However, most economists believe the slowdown was a head-fake and that growth will return to a rate around 3.5%, close to the economy's potential.
Looking ahead, the Bernanke Fed must deal with a slowing housing market, a large current account deficit and high household debt levels.
The Fed has now raised rates by a cumulative 3.50 percentage points, but rates remain low by historical standards, more than four years into the expansion.
The federal funds rate is the rate banks charge each other for overnight loans to comply with reserve requirements. By buying or selling Treasurys in the market, the Fed can set the interest rate and influence the price of credit.
A summary of the minutes of Tuesday's meeting will be released on Feb. 22. Economists will be reading the summary closely for clues to the Fed's strategy.
Another key date is Feb. 15, when Bernanke will present the Fed's economic outlook and his first discussion of recent monetary policy to the House Financial Services Committee. He'll testify at the Senate committee the next day.
Gruss Ice
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