Some Fed Officials Backed Rate Rise Soon, Minutes Say

By Craig Torres

July 16 (Bloomberg) -- Some Federal Reserve policy makers in June favored an increase in the benchmark U.S. lending rate ``very soon,'' according to minutes of that month's meeting.

The assessment came before last week's collapse in the stock price of Fannie Mae and Freddie Mac, the largest sources of American home financing, altered Chairman Ben S. Bernanke's views about growth risks. Bernanke abandoned the Federal Open Market Committee's June stance that the threat of an economic downturn had diminished in congressional testimony this week.

The economic outlook made the ``timing and magnitude of future policy actions'' unclear to the full committee, the records of the policy meeting said. Still, ``with increased upside risks to inflation and inflation expectations, members believed that the next change in the stance of policy could well be an increase in the funds rate.''

The FOMC on June 25 left the main interest rate at 2 percent, pausing after seven cuts that totaled 3.25 percentage points since September. Futures traders have priced in a 93 percent probability of no change at the Aug. 5 meeting.

There are ``significant downside risks to the outlook for growth,'' and ``upside risks to the inflation outlook have intensified,'' Bernanke said in semiannual testimony before the House Financial Services Committee yesterday and today.

`Fine Line'

Kansas City Fed President Thomas Hoenig said in a speech in Durango, Colorado, today that the level of interest rates ``almost certainly raises the risk of higher inflation.'' He said monetary policy must ``walk a fine line,'' supporting growth while ensuring prices remain anchored.

Risks to the economic outlook have risen after the Standard & Poor's Financials Index dropped 21 percent between June 25 and July 15. Shares of Fannie Mae and Freddie Mac, the largest sources of U.S. home financing, have slumped, prompting the Treasury and the Fed to announce a financial aid plan July 13.

``The big change has been this financial turmoil that goes along with Fannie and Freddie,'' said former Dallas Fed President Robert McTeer in an interview. ``Holding the financial system together has got to be their near-term priority. And they're not going to be raising anytime soon.''

Inflation Debate

The minutes show committee members wrestling with the inflation risks associated with record-setting oil prices, which have unseated consumers' outlook for near-term inflation, and whether demand could be hampered by tighter credit resulting from financial market turmoil.

Some members noted that the federal funds rate at 2 percent was negative after adjustments for inflation, a policy which ``could well lead to higher trend inflation.''

``With downside risks having diminished somewhat, some firming in policy would be appropriate very soon, if not at this meeting,'' some members argued. ``Other participants observed that the high level of risk spreads and the restricted availability of credit suggested that overall financial conditions were not especially accommodative.''

Prices paid by U.S. consumers jumped in June by the most since 2005 on soaring costs for fuel and food, the Labor Department said earlier today. The cost of living jumped 1.1 percent for the month, after a 0.6 percent gain the prior month. Prices increased 5 percent in the 12 months to June, the most since 1991.

Fisher Dissents

Forecasts in the minutes were identical to what Bernanke presented to Congress today and yesterday. Fed officials raised their projections for economic growth and inflation for this year, while reiterating their outlook for faster growth in 2009.

Dallas Fed Bank President Richard Fisher dissented in favor of a rate increase at the June meeting.

``Mr. Fisher was especially concerned about behavioral changes among business operators that appeared to be accommodating inflationary pressures'' by passing on higher input costs, the minutes said.

Fed bank presidents and the Board of Governors also discussed their discount window facility for investment banks, known as the Primary Dealer Credit Facility, and the Term Securities Lending Facility, which allows dealers to temporarily swap mortgage bonds and asset-backed securities for the Fed's holdings of Treasury notes.

``Participants also discussed the possibility of extending the PDCF and the TSLF past year-end,'' the minutes said. ``Participants exchanged views on longer-run issues regarding appropriate arrangements for supervision of investment banks.''

To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net