The Federal Reserve’s Open Market Committee today continued its course of raising its target for the federal funds rate by .25 percent, bringing it to 2.25 percent.

The move is the fifth hike in six months, beginning with a 25 basis point hike at the end of June, which was the first time the Fed had raised the rate in four years. The Fed appears poised for more rate hikes until it reaches what it considers a neutral monetary policy.

Mortgage rates have not followed suit yet, although most economists are predicting they will rise slowly throughout 2005. Last week, the 30-year fixed-rate mortgage averaged 5.71 percent, down from 5.81 percent the previous week, according to Freddie Mac’s weekly mortgage survey.

The Fed changed very little in its policy statement from its last meeting, saying it believes that even after today’s hike, its monetary policy remains accommodative. Combined with “robust underlying growth in productivity,” the monetary policy is providing ongoing support to economic activity, according to the Fed’s statement.

“Output appears to be growing at a moderate pace despite the earlier rise in energy prices, and labor market conditions continue to improve gradually,” the Fed wrote in its only wording change from last time. “Inflation and longer-term inflation expectations remain well contained.”

In last month’s policy statement, the Fed did not include the word “earlier” in reference to the rise in energy prices. It also previously said, “Labor market conditions have improved.”

The Fed retained wording from previous statements that policy accommodation can be removed “at a pace that is likely to be measured.” It said the committee would respond to changes in economic prospects as needed “to fulfill its obligation to maintain price stability.”

The federal funds target rate is what banks charge each other overnight. It has no direct impact on other rates, such as those for mortgages, but it can alter them indirectly.

A change in the federal funds rate, for example, is likely to change the prime rate, the rate banks charge their best corporate customers. That’s generally about three percentage points above the federal funds rate.

From there, any lines of credit tied to the prime rate rise as well. The yields on short-term Treasury bills generally move with changes in the federal funds rate, which also moves any adjustable-rate mortgages tied to short-term Treasury bills.

Fixed-rate mortgages are more closely aligned with the 10-year Treasury bond, and 30-year fixed rates tend to move closely with them. The 10-year Treasury bonds tend to reflect what the market is expected to do longer term, as well as anticipated changes in the federal funds target rate.


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