Fed dismisses Katrina fallout, raises key rate
11th straight jump puts pressure on Bank of Canada
Washington Bureau Chief WASHINGTON •
The Federal Reserve Board brushed off the devastation of Hurricane Katrina as a “near-term” setback to the world’s largest economy and proceeded with an expected quarterpoint hike in its key overnight lending rate to 3.75%.
The 11th consecutive jump, putting the rate at its highest level in four years, increases the pressure on the Bank of Canada to hike rates when it meets next month, said several economists.
“ The Fed’s action opens the way for another Bank of Canada rate hike on Oct. 18,” said Sherry Cooper, chief economist at BMO Nesbitt Burns in Toronto.
“The short answer is yes, particularly in the case of Canada,” said Bill Cheney, chief economist at MFC Global Investment in Boston.
Mr. Cheney noted, however, that the recent strength of the loonie may be weakening the Canadian economy outside the energy sector. This week, the Canadian dollar hit a 13-year high of US85.62¢. It was little changed yesterday.
“ That may be enough to make the Bank of Canada hesitate a bit longer before raising rates,” he said. The Bank of Canada rate is now one percentage point below the U.S. rate.
Meanwhile, stock and bond markets sank after Alan Greenspan, the U.S. Federal Reserve chairman, refused to blink from his “ measured” march to restore the Fed rate to what he sees as a more neutral rate sometime this year.
While noting that these “ unfortunate developments” in the Gulf of Mexico have created uncertainty about the strength of the US$ 11trillion economy, eight of the nine U.S. central bank governors insisted the setback from sharply higher energy rates, higher unemployment and other economic woes will be temporary.
“It is the committee’s view that they do not pose a more persistent threat,” the governors said.
Only Fed governor Mark Olson voted against hiking rates because of Katrina and now Hurricane Rita, which is moving toward the Texas side of the Gulf. His dissenting view was the first among voting governors of the Federal Open Market Committee since June, 2003.
The Fed, which has two meetings yet before the end of the year and three before Mr. Greenspan is set to retire, remains concerned that higher energy prices may translate into inflationary pressures.
“The bottom line: The strategy of gradually raising interest rates is not over, and unless the economy softens materially, more quarter-point hikes can be expected,” said Lynn Reaser, chief economist of the Investment Strategies Group at Bank of America in New York.
The Fed itself noted in its brief statement that it is worried about oil prices, which have been seesawing in recent days.
“ Higher energy and other costs have the potential to add to inflation pressures,” the Fed said. “ However, core inflation has been relatively low in recent months and longer- term inflation expectations remain contained.”
Katrina caused huge but apparently regionalized economic damage, now conservatively estimated at US$100-billion. It killed more than 900 people, put at least 400,000 people out of work and stripped about one half of 1% from expected economic growth in the second quarter, down to 3.6%.
“ The incoming data over the next month or so is certain to be filled with evidence of fairly widespread economic disruptions,” said David Greenlaw, chief economist at Morgan Stanley & Co. in New York.
“ Fed policymakers know this all too well and still stuck to a message that implies the tightening cycle is not yet complete,” he said.
Financial Post
pmorton@ nationalpost. com