The Federal Reserve hiked interest rates Tuesday and rattled investors by warning about rising inflation pressures, marking the first time in more than four years that the central bank has openly worried that prices might be climbing too quickly.
The Fed's shift raised the prospect that interest rates could be headed significantly higher this year, which in turn could slow the economy -- and particularly the still-booming housing market.
Nervous investors drove the Dow Jones industrial average to its lowest close since late January, while interest rates on long-term Treasury bonds surged to their highest levels since June. Mortgage rates tend to follow bond rates.
At its regularly scheduled meeting Tuesday, the Fed lifted its key short-term interest rate by a quarter-point, to 2.75% -- the seventh such increase since June. The move had been anticipated as the central bank brings interest costs back into line with the growing economy.
In a surprise, however, policymakers said in their post-meeting statement that "pressures on inflation have picked up in recent months" and that "pricing power is more evident," meaning that some businesses have been better able to boost prices of goods and services.
Concerns about higher inflation haven't appeared in a Fed statement since November 2000. In its previous statement after its Feb. 2 meeting, the Fed simply referred to inflation as being "well contained."
On Wall Street, which is alert to every nuance in Fed utterances, the new wording was widely viewed as a warning that the central bank might begin raising interest rates more aggressively, which could put the brakes on consumer and business spending.
"The Fed is very explicitly concerned about inflation expectations," said Amitabh Arora, an interest rate strategist at brokerage Lehman Bros. in New York. "The only thing in their armory to contain those inflation pressures is short-term interest rates."
The Fed's stance is a dramatic turnabout from two years ago, when policymakers were worried about a lack of inflation. Then, they feared that the economy faced a greater risk of a debilitating deflation, or declining prices, similar to what ravaged Japan in the 1990s.
That was the main reason the Fed slashed its benchmark rate to a generational low of 1% in 2003 and kept it there until last June. But with the rebound in the global economy over the last two years, deflation worries have dissipated. Last year, surging prices for oil and other commodities began to raise the specter of worrisome inflation.
