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Fed likely to raise rates another quarter-point

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The Federal Reserve is widely expected to raise interest rates another quarter-point Tuesday despite the latest evidence that economic growth is slowing. But Friday’s report of weak job growth in July opens the possibility the Fed might hold off from raising rates again until after the Nov. 2 election, analysts say.

Fed Chairman Alan Greenspan and his central bank colleagues voted to hike the  benchmark overnight lending rate for the first time in four years June 30, raising it to 1.25 percent from a 46-year low of 1 percent. While the rate hike itself will have only a minor impact on consumer and business lending costs, Fed officials repeatedly have said they plan to continue raising rates in a “measured” response to improving economic conditions.

The assumption was that the Fed would continue to raise rates, a quarter-point at a time, at almost every meeting of policy-makers well into 2005. But two straight months of weak job growth have called that forecast into question.

“What looked to be more like a preprogrammed set of rate hikes is no longer certain,” said Stephen Stanley, chief economist for Greenwich Capital Markets “Now everything is on the table beyond tomorrow. Nobody can be all that confident in their forecast.”

Analysts and investors will be paying close attention to the statement that accompanies the Fed decision Tuesday, which is expected to be announced at 11:15 a.m. ET. In congressional testimony last month, Greenspan said the economy hit a “soft patch” in June but appeared to be rebounding.

Most economic data have appeared to support his optimism, including rising car sales, improving consumer confidence and surveys indicating strong business activity.

“The one piece of the puzzle that obviously didn’t rebound in July was the employment situation,” said Stanley. “That challenges everyone’s assumptions about where the economy is headed. I don’t think anyone can be sure now about where we are headed,  because the numbers are headed in different directions.”

The employment data and Fed policy decisions take on added significance because of the economy’s critical role in the presidential election campaign. Democratic challenger John Kerry has made job creation a central part of his economic platform. President Bush, meanwhile, argues that the economy is strong and “getting stronger,” at least partly because of the tax cuts he pushed through Congress.

Stanley and other economists say the rising price of oil appears to be one of the main reasons the economy has slowed so much more sharply than anticipated. The rising cost of gasoline and other fuels acts as a tax on motorists, eating into disposable income, while forcing many businesses to either raise consumer prices or accept smaller profits.

“For the Fed it’s not clear exactly how to respond,” Stanley said. “It’s always been a tough call for the Fed how to deal with oil price shocks.”

Most analysts still believe the Fed will continue to raise interest rates well into next year simply because they are so low by historical standards.  The Fed cut rates 13 times from early 2001 until mid-2003, but many of those rate cuts were considered “insurance” against risks to the financial system, said Bob Gay, global strategist for Commerzbank Securities.

In particular the Fed was worried as recently as last year about the remote but potentially devastating possibility of deflation, or broadly falling prices.

“If the systemic risk is gone, they need to withdraw the insurance policy,” Gay said. He figures that the Fed has to raise the federal funds rate to 2 percent by the end of the year and then to at least 3 percent by next year just to get close to a level considered “neutral” for the economy. And he said the Fed will not hesitate to continue raising rates “no matter what rate of job growth we have, as it’s not negative.”

Still, financial markets, which once had seen the Fed as almost certain to raise rates again at its next meeting of policy-makers Sept. 21, now see the odds of a rate hike next month as only 50-50. Gay points out that for the Fed to skip a rate hike Sept. 21 could be seen as political, since most voters presumably would prefer to see the persistence of lower interest rates.

“None of this has anything to do with politics,” said Gay, a former Fed economist.

But Greenspan has plenty of experience with the intersection of central bank rate policy and presidential politics. In 1992, the first President Bush and his senior aides criticized Greenspan harshly for allowing the economy to fall into recession and then failing to cut rates aggressively enough to boost growth.

The Fed did cut its benchmark rate by a quarter-point in September of that year, two months before Bill Clinton defeated Bush in an election that hinged largely on the economy.