By Martin Wolk Chief economics correspondent
msnbc.com
updated 3/21/2005 6:06:34 PM ET 2005-03-21T23:06:34

Federal Reserve Chairman Alan Greenspan and his fellow policy-makers will try to make it business as usual Tuesday when they are widely expected to raise short-term interest rates for a seventh straight time. But signs of rising inflation — even before the latest surge in energy prices — are putting pressure on the central bank to change its formal policy statement and possibly accelerate the rate-hiking cycle.

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Wall Street analysts and economists almost universally expect the Fed to raise benchmark rates another quarter-percentage point Tuesday, as it has done after every scheduled meeting of its Open Market Committee since last June. And few analysts expect a significant change in the Fed’s statement calling for “measured” rate increases to keep a lid on inflation.

Most analysts, however, seem convinced that by midyear the Fed will remove the word “measured,” which has been featured in the policy statement since May 2004. By removing it, the Fed would signal it is more open to the possibility of a half-point rate hike if needed.

“While it's in no one's forecast, the historical record tells us that there has not been one tightening cycle in the past 30 years in which the Fed failed” to hike rates by a half-point at least once, said David Rosenberg, Merrill Lynch chief North American economist, in a conference call last week.

But significant change in the policy language is considered unlikely Tuesday because of the Fed’s preference to do things gradually and with plenty of warning.

“The Fed is very good at taking baby steps,” said Mary Ann Hurley, a bond trader at D.A. Davidson & Co. in Seattle. If the Fed removes the word “measured” Tuesday, “it will cause havoc to both the bond market and the stock market,” she said.

Bond market interest rates already have been rising and stocks have been sliding in part because of concern over inflation. One key indicator of inflation watched by the Fed showed an increase of 0.3 percent in consumer prices in January — the biggest monthly rise in two years. Wholesale prices showed their biggest increase in seven years.

And those figures exclude the soaring costs of fuel including crude oil, up more than 30 percent so far this year.

“In the past anytime oil has gone up to this degree it has hurt consumer spending,” Hurley said. “I frankly don’t see how they could not be concerned with that.”

Despite the rising energy prices, consumer spending has stayed resilient so far. Retail sales were up a healthy 0.4 percent in February excluding autos and gasoline, perhaps reflecting a surge in refunds to federal taxpayers who filed their returns early and electronically.

That economic boost will fade soon, and in its place the economy eventually is likely to feel the pinch of higher pump prices and the delayed impact of rising interest rates.

When the Fed began raising rates in June, its benchmark overnight rate for loans between banks was at an extraordinarily low 1 percent. After Tuesday’s meeting the rate likely will stand at 2.75 percent on its way to a so-called neutral level that many analysts put at 4 percent or above.

Such changes typically take six to 12 months to work through the economy, but a loan at the new prime rate of 5.75 percent certainly will not be the bargain it was last summer at 4 percent.

And long-term rates finally are rising, as well — a potentially worrisome development for the nation’s red-hot housing market. Even as the Fed was raising rates through the second half of last year, long-term mortgage rates were falling, but over the past several weeks they have reversed course and recently hit their highest level in seven months .

Other long-term rates are rising on credit markets, where investors have been spooked by troubles at General Motors Corp., one of the biggest borrowers in the corporate world.

Greenspan, who last month described the persistence of low long-term rates as a "conundrum," might be satisfied that more of the factors affecting the economy are moving in the same direction, making the Fed’s job easier.

But the Fed faces a tough balancing act, particularly if officials see signs that energy price increases are being passed on to other sectors of the consumer economy. Then Greenspan and his colleagues will have to decide how aggressively to raise rates at a time when the economy already might be at risk of a sharp slowdown.

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