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Fed raises rates again
Central bank boosts key short-term rate to 5%, says further hikes 'may yet be needed' depending on economic reports.
By Paul R. La Monica, CNNMoney.com senior writer

NEW YORK (CNNMoney.com) - The Federal Reserve raised a key interest rate again Wednesday - the 16th straight increase - but the central bank didn't give Wall Street what it had hoped for: a definitive answer about what to expect in the coming months.

The Fed raised its short-term rate target another quarter-point to 5 percent and said it may need to keep raising rates, but that the timing of any increases will depend on how the economy is doing.

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Eyes on the Fed
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Recent report shows the central bank chairman, committed to more openness, needs to choose his words more carefully. (more)

The central bank has been hiking rates for 22 months in a bid to keep inflation at bay. But despite concerns about rising energy prices, as well as signs that the economy is still healthy, there is a growing feeling among some economists and investors that the Fed risks hurting economic growth if it keeps boosting rates.

"Some further policy firming may yet be needed to address inflation risks but ... the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information," the Fed said in its statement. (To read the statement, click here.)

David Joy, chief market strategist with money manager RiverSource Investments, said the second part of the sentence was interesting. He thinks it proves that the Fed would prefer to not have to raise rates again in June.

"Basically, they're saying two things. Future action is data dependent and that they may very well pause in June in order to buy themselves some time. This increases the likelihood of a pause in June and is about as explicit as they will allow themselves to be," Joy said.

But investors didn't seem to know quite how to react.

Stocks traded lower just before the Fed announcement, then turned mixed before turning mostly lower in late afternoon trading. (Full story).

Bonds initially fell and were little changed late in the session, leaving the yield on the 10-year Treasury at about 5.12 percent.

One economist said the statement seems to indicate a June pause was possible but that the wording was still nebulous enough to give the Fed some wiggle room.

"The only thing they didn't say they might do is cut rates," said Keith Hembre, chief economist with First American Funds in Minneapolis.

To pause or not to pause?

The central bank's fed funds rate now stands at 5 percent, the highest since March 2001. Short-term rates were at historical lows when the Fed began its rate-hiking campaign in June 2004.

The fed funds rate, an overnight bank lending rate, affects the rates consumers pay on credit cards, auto loans, home equity lines of credit and other types of debt. As such, several banks reported that they were increasing their prime lending rate to 8 percent after the Fed's announcement.

In its statement, the Fed said that "economic growth has been quite strong so far this year" but that growth "was 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."

Fed Chairman Ben Bernanke made similar comments about the economy last month in remarks to the Joint Economic Committee of Congress. During that testimony, Bernanke also hinted that the Fed could soon pause to judge the impact of the Fed's previous interest rate hikes.

But last week, CNBC anchor Maria Bartiromo reported that Bernanke told her he was disappointed that investors took his testimony to mean that he wasn't going to be tough on inflation. That remark sent stocks sinking and bonds lower as investors started to doubt the Fed would pause in the next few months.

So that's one reason investors were hoping for more clarity from the Fed's statement Wednesday.

The Fed's next policy meeting is on June 28 and 29. According to rate futures on the Chicago Board of Trade, before the Fed's announcement Tuesday investors were betting on a 38 percent chance of another quarter-point hike at that meeting. But after the statement was released, the bets rose to 42 percent.

Hembre at First American Funds said he still thinks a June pause is likely since he doubts we'll see much evidence between now and then to suggest the economy will maintain its heady pace of growth for the rest of the year. With that in mind, the Fed would be likely to pause to avoid raising rates too far.

"Growth through the first part of the year is obviously strong but inflation numbers are still contained. That's a positive," he said. "And it's unlikely the data over the next six weeks will be sufficiently one-sided enough to challenge the view that the economy will slow later this year."

But Jeff Cummer, manager of the SMH Capital Advisors Integrity High Income fund, said investors should be prepared for more rate hikes, even if the Fed pauses in June.

To that end, investors are pricing in an 82 percent chance that short-term rates will be at 5.25 percent by the beginning of September, which implies that investors expect a rate increase at either the Fed's June meeting or the meeting after that on Aug. 8.

Cummer said that as long as the economy shows fairly strong growth, there will be pressure on the Fed to keep raising rates, especially since there's speculation that central banks in other countries, notably Japan, may soon be raising rates as well.

"As long as the economy is rolling along, we can take a few more hikes," he said. "A pause in June may mean the Fed doesn't want to raise rates much more but it doesn't mean they won't raise rates. We are likely to see interest rates rising abroad."

And Joy at RiverSource Investments conceded that the Fed, while hinting it would like to pause, refused to paint itself into a corner. He said it would be worse for the Fed and the markets if it clearly signaled a pause and then doesn't pause.

"The Fed doesn't know what the data between now and June will look like and they don't want to have to backtrack," he said.


Rising energy prices were supposed to cool the economy. Not yet.

Read the Fed statement. More here.

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Federal Reserve
Interest rates
Ben Bernanke
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