The FOMC Raises Target Rate to 5%

As was widely expected, the Federal Open Market Committee voted today to raise the target federal funds rate to 5%. Of more interest are changes in the wording of the Press Release that signal the course of future policy. The key differences from the last statement are:

Worries that the slow growth observed in the fourth quarter might carry forward have disappeared and growth is now describes as "quite strong so far this year."

As before, the committee expects growth to moderate, but in this statement the committee mentions three factors expected to contribute, the cooling of the housing market, and the lagged effects of interest rate increases and the lagged effects of increases in energy prices.

This statement emphasizes that the extent and timing of any further moves will depend importantly on the evolution of the economic outlook as implied by incoming information.

The risk assessment statement is changed - this statement only mentions the inflation risk, whereas the last statement discussed balancing the risks between inflation and sustainable growth.

And, it is worth noting that once again Kansas City did not request an increase in the discount rate, a signal that they may have had doubts about increasing the target rate.

The bottom line? I expect a pause at the next meeting if the Fed observes signs of the anticipated slowdown and if inflation remains moderate. However, they are very careful to signal that nothing is set in stone, the next move will depend critically on observations of the current and expected future state of the economy. Here's a comparison of the two statements highlighting the differences:

May 9, 2006 FOMC Meeting	March 28, 2006 FOMC Meeting
For immediate release The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 5 percent.	For immediate release [No substantial difference]
Economic growth has been quite strong so far this year. The Committee sees growth as likely to moderate to a more sustainable pace, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.	The slowing of the growth of real GDP in the fourth quarter of 2005 seems largely to have reflected temporary or special factors. Economic growth has rebounded strongly in the current quarter but appears likely to moderate to a more sustainable pace.
As yet, the run-up in the prices of energy and other commodities appears to have had only a modest effect on core inflation, ongoing productivity gains have helped to hold the growth of unit labor costs in check, and inflation expectations remain contained. Still, possible increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures.	[identical]
The Committee judges that some further policy firming may yet be needed to address inflation risks but emphasizes that the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information. In any event, the Committee will respond to changes in economic prospects as needed to support the attainment of its objectives.	The Committee judges that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance. In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Jack Guynn; Donald L. Kohn; Randall S. Kroszner; Jeffrey M. Lacker; Mark W. Olson; Sandra Pianalto; Kevin M. Warsh; and Janet L. Yellen.	[also unanimous]
In a related action, the Board of Governors unanimously approved a 25-basis-point increase in the discount rate to 6 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Dallas, and San Francisco.	In a related action, the Board of Governors approved a 25-basis-point increase in the discount rate to 5-3/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Dallas, and San Francisco.

Update: William Pollley comments.

Comments

[dryfly]

You wrote in the last box on the left...

In a related action, the Board of Governors unanimously approved a 25-basis-point increase in the discount rate to 6 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Dallas, and San Francisco.

Six percent? They didn't say that did they? Did I miss a few hikes somewhere or was that a typo? If a typo was it yours or theirs? Just curious.

[Mark Thoma]

dryfly: That's the discount rate, the rate the Fed charges for loans to banks, and it is always set (currently anyway) at 1% above the ff rate. It serves as a cap on the rate - if the ff rate tries to go above 6%, people will borrow from th eFed instead of from the ff market.

Since KC did not ask tht it be increased from 5.75% to 6.0% indicates they did not favor increasing the ff rate (technically each bank sets the rate, but it must be approved by the Fed and they only approve ff+1%).

[dryfly]

Thanks Mark - I know NOTHING, NOTHING about banking (spoken like Sargent Schultz for you old enough to remember)... I saw that number and had a horrible Rip Van Winkle like feeling that I'd missed a whole lot somewhere.

Though me missing something like that isn't outside the bounds of possibilities, lol... thanks again.

[Cassandra]

Other things being the same, (no change in fiscal gaps, Japanese ZIRP or near-ZIRP, and little change in thhe exchange rate of the USD), the entire yield curve is going higher - pause or no pause. Without help on the fiscal side, or from MoF, BoJ, PBoCA, the Fed is sort of chasing it's tail: for as soon as they raise the discount rate and funds target on the short end, the market says, "not enough" and pushes the long end further preventing the neutral position that it is seeking.

And when we are most need friends, Cheney, Rumsfeld & Snow are simultaneously out there insulting our sources of funds, while our middle east policies alienate the balance of potential sources of finance. If the administration desires a market-based solution to US financial problems, they should put on their seat-belts NOW!