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Fed Moves to Hike Discount Rate

WASHINGTON (CN) - In a surprise move, the Federal Reserve on Friday raised rates for the first time in more than 2 years, hoisting the discount rate by 0.25 percent. The bump signaled gradual withdrawal of its inflation-threatening market support, despite a drop in prices for the first time in nearly three decades. The rate hike and price drop highlight the potential for volatility in prices.

The interest rate hike, decided Thursday afternoon, jolted European and Asian markets, which saw stocks prices fall overnight. American stocks only suffered minor decreases.

The 0.25 percent increase from 0.5 to 0.75 percent marks the first time the central banks raised any interest rate since the summer of 2007, when the housing bubble burst, and represents a small step towards removing the props the Fed has placed under faltering banks

The increase in discount rates -- paid by banks who seek out the Fed for emergency loans -- could slim the profits of banks, although most banks already try to avoid such borrowing, fearing the stigma. And mortgage rates and credit-card rates won't be affected.

The largely symbolic move of increasing the cost of a small portion of loans illustrates the Fed's concern over inflation.

However, the more important federal funds rate -- which is placed on short-term loans that banks make to other banks -- remains at a record low of near-zero percent. In last week's testimony to Congress, Bernanke suggested that it would be too soon to raise these interest rates, given the continued fragile state of the economy.

Bernanke laid out the Fed's plans to combat the threat of inflation by eventually soaking up the hundreds of billions of dollars in cash it poured into the financial market in responding to the recession, but holding-off on that move reflects only a distant concern over inflation.

A same-day report by the Bureau of Labor Statistics indicates that inflation has so far been held at bay, showing that prices -- excluding those on food and energy -- fell by 0.1 percent in January. The drop in prices is the first since the end of the recession in 1982. Market analysts often prefer to look at prices excluding food and energy because their prices are so volatile.

It is stirring concerns over deflation, although prices increased by 2.6 percent over the past year.

Concerns over future inflation are fed by the prospect of banks lending money anew, after carefully holding money in reserve, and by the hundreds of billions of dollars still sitting in the market after being injected by the Fed as a response to the downturn.

But the Fed downplayed the psychological and market effect of the move. "The modifications are not expected to lead to tighter financial conditions for households and businesses" the Fed said in a statement released Thursday, adding that the decisions "do not signal any change in the outlook for the economy or for monetary policy."


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