Fed Keeps Pressure On

The FOMC raises fed funds by a quarter-point to 3.75% and vows to remain 'measured.'
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Updated from 2:59 p.m. EDT

The

Federal Reserve

raised official U.S. interest rates by another quarter-point Tuesday, sticking to its 15-month-old anti-inflation blueprint while acknowledging the economic stress created by Hurricane Katrina and its impact on energy prices. The Fed retained its commitment to a "measured" schedule of future rate hikes.

The Federal Open Market Committee raised its fed funds target to 3.75% -- its 11th consecutive 25-basis-point tightening. Although generally expected, the decision was the first to involve any legitimate drama since the Fed began pushing rates higher in June 2004. Indeed, one Fed governor, Mark Olson, voted to leave rates unchanged.

Hawkish language in the accompanying policy statement reversed early gains in the stock market. The

Dow Jones Industrial Average

closed down 76 points to 10,4782. Bond yields were steady.

The committee's assessment of current economic conditions was radically changed from previous statements, reflecting Katrina.

"The widespread devastation in the Gulf region, the associated dislocation of economic activity, and the boost to energy prices imply that spending, production, and employment will be set back in the near term," the FOMC wrote. "In addition to elevating premiums for some energy products, the disruption to the production and refining infrastructure may add to energy price volatility.

"While these unfortunate developments have increased uncertainty about near-term economic performance, it is the committee's view that they do not pose a more persistent threat. Rather, monetary policy accommodation, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity," the FOMC wrote.

"Higher energy and other costs have the potential to add to inflation pressures. However, core inflation has been relatively low in recent months and longer-term inflation expectations remain contained," the Fed said.

The Fed left its price-risk assessment unchanged.

"The committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, the committee believes that policy accommodation can be removed at a pace that is likely to be measured," it said.

Economic data heading into Tuesday's announcement were mixed, with signs of tame inflation in the producer and consumer price indices contrasting with the choppy appreciation in oil and gasoline markets following Katrina's Aug. 29 landfall. Heating oil futures, in particular, have staged a major rally in the storm's aftermath.

Katrina has also raised concerns about U.S. fiscal policy and long-term economic growth. President Bush has committed more than $60 billion to rebuilding the storm-racked Gulf Coast, and some estimates of the storm's overall cost are above $200 billion. Consumer sentiment plunged and first-time jobless claims surged in September, although many economists expect the effects to be short-lived.

Treasury Secretary John Snow previously estimated that Katrina would cost the U.S. up to a percentage point of growth in its gross domestic product this year.

Complicating the Fed's calculus, Tuesday's meeting occurred as another storm, Hurricane Rita, churned westward through the Gulf of Mexico. Current forecasts have Rita making landfall toward the end of the week somewhere on the Texas coast.

In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

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