By Martin Wolk Executive business editor
msnbc.com
updated 12/13/2004 4:05:09 PM ET 2004-12-13T21:05:09

Another meeting, another quarter-point.

Major Market Indices

Federal Reserve Chairman Alan Greenspan and his central bank colleagues are widely expected to raise short-term interest rates for a fifth and final time this year Tuesday.

The Fed’s expected move will bring the key overnight lending rate to 2.25 percent, the highest level in more than three years, as the central bank continues to tighten credit steadily after an interlude of historically low interest rates.

So far the Fed’s campaign to restore interest rates to more normative levels has gone like clockwork despite a surge in oil prices over the summer and mixed economic signals more recently.

Greenspan and other Fed officials began signaling in May that they intended to restore higher rates in a “measured” fashion, and they have stuck with their game plan.

Beginning June 30, the Fed’s policy-making Open Market Committee has raised its benchmark rate a quarter-point at every scheduled meeting, and the panel generally is expected to raise rates at least one more time Feb. 2 when it concludes its next meeting. Rate hikes filter through to consumers and businesses in the form of higher costs for credit card borrowing, home equity loans and other financial transactions.

Funds rate could pass 4 percent
Many economists expect the central bank to continue its campaign for much of next year, even as Greenspan concludes his long tenure as Fed chief, which is scheduled to end in early 2006. Greenspan, 78, is not eligible for reappointment when his current term at the Fed expires.

Many analysts expect the Fed to push the overnight, or federal funds, rate past 3 percent and possibly to 4 percent as it seeks to find a “neutral” level that would encourage steady economic growth without triggering faster inflation.

“Normal means fed funds in the 4 to 4.5 percent range, the economy growing at a 3 to 3.5 percent pace and unemployment filtering down, but not much below 5 percent,” said Joel Naroff of Naroff Economic Advisors. “That’s where I think they are headed, and they could get back there by the end of next year.”

But not everyone agrees. Some analysts, especially bond market analysts who follow the interest rate movements slowly, believe the Fed may pause in its tightening cycle soon for fear of choking off economic growth.

Fed officials “are going to be very quick to hit the brakes on rising rates” if evidence of economic weakness emerges early next year, said Mary Ann Hurley, a bond trader at D.A. Davidson & Co. in Seattle.

She said a report of weak hiring last month could be a sign of things to come next year, when the economy will no longer be benefiting from the tax cuts, mortgage refinancing and other stimulus that helped in the first half of 2004.

She and some other analysts said Greenspan is wary of repeating a 1994-95 mistake when the Fed raised its benchmark rate from 3 percent to 6 percent in less than a year, nearly short-circuiting the nascent economic expansion.

“They don’t want a repeat of ‘94,” she said. “This economy is totally dependent on low rates.”

This time around Greenspan has been careful to give financial markets plenty of warning about rate-hike plans, making Tuesday’s meeting a “non-event” in the words of one analyst.

“That is absolutely intentional,” said Naroff, who expects little change in the wording of the closely watched statement the Fed will issue along with its announcement on interest rates. “They are essentially sending the signal that everything is going to stay the same.”

Since the Fed’s last meeting Nov. 10, the stock market has surged but the dollar has fallen sharply against European currencies, raising some concerns about what would happen if the dollar were to tumble precipitously. Many analysts cite the falling dollar as the No. 1 economic risk for 2005, especially if it triggers a sharp rise in long-term interest rates.

So far long-term rates have been surprisingly unaffected by the Fed’s efforts to raise short-term rates. If mortgage rates were to head sharply higher, that probably would undermine the housing market, which has been an untiring engine of economic growth.

The Fed traditionally does not comment on currency movements so might not mention the topic in its carefully worded statement Tuesday. But Greenspan shook financial markets last month when he predicted the dollar would continue declining unless the United States took steps to reduce its current account deficit, including reducing the federal budget deficit.

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