The Federal Reserve lifted short-term interest rates a half-percentage point to their highest level in nearly four years yesterday -- the seventh boost in 12 months -- and warned that the economy has not yet cooled enough to keep inflation under control.
For millions of consumer and business borrowers, the Fed's move will quickly mean an increase in the cost of credit. For savers, it may eventually lead to higher rates on certificates of deposit and money-market accounts.
The key federal funds rate, which banks charge each other for overnight loans, rose to 6 percent. The last time it was that high was from March 8 through April 30, 1991. Twelve months ago, before the Fed began to tighten on Feb. 4, 1994, it was 3 percent.
The discount rate, which the Fed charges to banks, also rose a half-percentage point, to 5.25 percent.
In a terse statement announcing the move at the end of a two-day meeting, the Fed dismissed warnings by politicians and some economists that it may be overtightening and risking a recession this year.
"Despite tentative signs of some moderation in growth, economic activity has continued to advance at a substantial pace, while resource utilization has risen further. In these circumstances, the Federal Reserve views these actions as necessary to keep inflation contained," the Fed said. Banks responded within hours by raising their benchmark prime rates by the same amount, most of them to 9 percent. Among the first to announce were four operating in Maryland -- NationsBank Corp., First Fidelity Bank Corp., Citicorp and Chase Manhattan Corp.
The higher prime will instantly raise the cost of many business loans, and in a few weeks it will boost the interest on most credit card balances and some adjustable rate mortgages.
By the end of March, a typical adjustable-rate credit card, with interest that might have been 11 percent a year ago, will cost 14 percent.
Savings rates usually move up more slowly. A typical 12-month CD, which might have yielded about 3 percent a year ago and yields about 5.5 percent today, might be expected to yield about 6 percent by April or May, economists said.
For Maryland, which has lagged behind the rest of the country and struggled to recover from the recession, higher interest rates are especially bad news, economists said.
The state has little but consumer spending and housing construction to drive its growth, and both are among the parts of the economy most sensitive to interest rates, economists who follow the region said.
"This only adds to the headwinds Maryland is facing. As these interest rates slow the U.S. economy still further in the second half of this year, this state will have even more serious problems," said Charles W. McMillion, president of MBG Information Services, a Washington, D.C., consultancy that tracks the regional economy.
Wall Street, which had nosedived after the Fed's first few interest-rate bumps and rocketed after some later ones, took the latest move in stride.
The Dow Jones industrial average lost 15 points from the day's high after the 2:05 p.m. announcement, but it ended the day up 3.70 points, at 3,847.56. The yield on the benchmark 30.25-year U.S. Treasury bond closed at 7.75 percent, up from Tuesday's close of 7.69 percent, but it showed no sign of heading back toward its December peaks of more than 8 percent.
The Fed is now easing into the most sensitive phase of its year-old drive to engineer a "soft landing" by cooling the economy enough to head off serious inflation without tightening the screws so hard it brings on a recession, economists said.
"From here on, the balancing act becomes very delicate," said NationsBank Corp.'s chief economist, Alfred G. Smith III. "And the Fed does have some history of overstaying its leave, though I think they are right when they say it's easier to correct a too-tight policy than a too-loose policy."
On the one hand, credit card borrowing reached all-time highs late last year, suggesting that the combination of soaring balances and rising interest rates may soon put the brakes on consumer spending.
"Consumer debt was already high going into December, and people are just now getting the bills for their Christmas shopping. And all the signs are that those are going to be pretty stiff -- it probably won't be like turning off a switch, but there's likely to be a slow erosion of consumer spending," Mr. Smith said.
On the other hand, the economy was still growing very fast in December, and factories worked at a higher percentage of capacity -- a yardstick the Fed watches closely -- almost every month in 1994.
"I think we'll see a slight bump in inflation in this quarter, which will move the Fed to bump rates again in April or May," Mr. Smith said. "We have already factored a federal funds rate of 6.75 percent by this spring into our economic planning."
Long-term interest rates, including the key mortgage rates that influence Maryland's housing construction industry, are likely to go up temporarily this winter and spring, economists said.
But a slowing economy will bring mortgage rates back down later in 1995, and they will end the year well below today's rates of just over 9 percent, economists said.