Fed Speakers Insist Discount Rate Hike Not Sign Of Policy Tightening

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The U.S. Federal Reserve has insisted that Thursday night's move to increase the discount rate by 25 basis points is not a sign that a tightening of monetary policy is imminent. The speculation was played down by two Fed Presidents in two separate speeches late Thursday.

Fed Chairman Ben Bernanke mooted the move last week, saying the central bank was aiming to widen the spread between the federal fund rate and the discount rate at which banks can borrow from the Fed.

But the hike in the discount rate, which was announced after the close of trading for the day, was not anticipated so soon and drew an immediate spike in the U.S. dollar on feelings a tightening of credit was imminent.

Atlanta Federal Reserve President Dennis Lockhart said the Fed's action should not be viewed as a tightening of monetary policy or even a sign that a tightening is imminent.

"Today's action is another example of the removal of the special credit and liquidity facilities put in place in response to the financial crisis," Lockhart told in a prepared speech to the Augusta Metro Chamber of Commerce in Georgia.

He pointed out that a number of the Fed's special credit facilities are coming to an end in the beggining of the year and said that this is happening because "stress in the financial system had abated", and that today's move should be seen as a "normalization step".

"My point is that the public and markets should not misinterpret today's move," said Lockhart. "Monetary policy - as evidenced by the federal funds rate target - remains accommodative."

"This stance is necessary to support a recovery that is in an early stage, and, in my view, still fragile."

The Atlanta Fed chief said that there are two paths that the recovery could take. In the first, growth exceeds the long-term trend potential of the economy and unemployment declines at an accelerated pace.

The alternative path, Lockhart continued, is one where growth continues, but at a very modest pace, and unemployment is very slow to recede.

However, the central banker was unsure of which path the recovery will take, and for this reason, he said monetary policy must be "nimble" to react to both scenarios.

Meanwhile, St.Louis Fed President James Bullard reacted to speculation of the possibility of a interest rate hike "overblown" and that the discount rate move should not be interpreted as a policy signal.

"The discount rate move is part of a normalization process which is akin to our discounting many of our liquidity programs," media reports quoted Bullard as saying in Memphis, Tennessee.

"It does not indicate anything one way or another about what we might eventually do with the federal funds rate," he added.

The discount rate is what the Federal Reserve charges banks for emergency credit support. It had been lowered to 0.50% in August 2007 to encourage banks to borrow credit from the Fed - one of the first measures to calm markets in the wake of the financial crisis.

The U.S. dollar pared its gains against major opponents after reassurances from Fed officials that there was no immediate risk of policy tightening.

The U.S. Federal Reserve has insisted that Thursday night's move to increase the discount rate by 25 basis points is not a sign that a tightening of monetary policy is imminent. The speculation was played down by two Fed Presidents in two separate speeches late Thursday. (Market News Provided by RTTNews)