Fed Raises Rates for Third Time This Year; Adopts Neutral Bias

The Federal Reserve raised interest rates by 25 basis points today, raising its target for the fed funds rate to 5.50% from 5.25%. Wall Street was evenly split on whether the Fed would hike or not, but the Fed was apparently concerned enough about rising inflation to boost rates for a third time this year.

In its announcement, however, the Fed said it was adopting a neutral directive, after adopting a bias toward raising rates at the Oct. 5 meeting. This indicates the Fed has no predilection toward raising or lowering rates at the next meeting, Dec. 21, the last of the year.

Most believe this will be the Fed's last move in 1999. Only the Dec. 21 Federal Open Market Committee meeting remains, and the committee is expected to stand pat due to concern about potential economic disruptions related to the Y2K date change. Beyond that, Y2K threatens to distort economic data too much for the Fed to get a clear read.

In its statement, the Fed said that "although cost pressures appear contained, risks to sustainable growth persist. ... As a consequence, the pool of available workers willing to take jobs has been drawn down further in recent months, a trend that must eventually be contained if inflationary imbalances are to remain in check and economic expansion continue."

Economists said this Fed meeting was the closest call in a long time. Productivity and labor cost figures show that producers are continuing to meet consumer demand without a rise in wage inflation, but the Fed's greater focus was on the ever-tightening labor market. The unemployment rate fell to 4.1% in October, lowest in almost 30 years.

In an Oct. 28 address, Fed Chairman Alan Greenspan expressed concern over labor market tightness. "The number of workers drawn into employment in excess of the normal growth in the workforce has been running at the equivalent of roughly a half of a percentage point of annual GDP growth," he said. "This gap must also eventually be closed if inflationary imbalances are to continue to be contained."

Today's action reverses all three cuts undertaken during last year's global economic crisis, which brought the short-term lending target to 4.75%. The Fed maintained a 5.5% funds rate between March 1997 and September of last year, the longest length of time without a change in policy since Greenspan was appointed Fed chairman.

The fed funds rate is the rate banks charge one another for overnight loans. The Fed keeps it in line with its target through open market operations -- buying and selling government securities so that the money supply matches demand at that level.

The Fed also raised the discount rate, to 5% from 4.75%. The discount rate is the rate the Fed charges member banks to borrow from its discount window.