Fed likely to raise rates another quarter-point

/ Source: msnbc.com

Last week’s strong employment report virtually guarantees that Federal Reserve Chairman Alan Greenspan and his colleagues will raise interest rates again Wednesday and probably one more time this year, analysts say.

The central bank is expected to raise the benchmark overnight lending rate by a quarter-percentage point to 2 percent, up from 1 percent in June, when the Fed began its campaign  to bring rates up from the lowest levels in 48 years.

Only a disastrous employment report Friday could conceivably have stopped the Fed from raising rates this week for the fourth time in little over four months, analysts said. Instead, the Labor Department reported that U.S. employers added 337,000 jobs in October, the best performance in seven months.

Including an upward revision to previous figures, the report indicated the economy has added an average of 225,000 jobs a month over the past three months, substantially more than needed to absorb the number of new workers entering the labor force.

The figure touched off a bit of economic euphoria among some analysts to go along with the post-election euphoria that has sent major stock indexes sharply higher over the past week.

“It tells us there is a little more momentum than we thought previously,” said Nigel Gault, managing director for Global Insight, a forecasting firm. “It suggests the recovery is quite well-established, where output growth generates income growth in a virtuous circle.”

He said the report was particularly encouraging in light of a sharp increase in oil prices that contributed to a worrisome economic slowdown over the summer.

But Gault and other analysts said the economy still faces challenges ahead, including the delayed effect of persistently higher energy prices.

And the Fed will have to consider the potentially inflationary effect of a sharp drop in the value of the dollar against the euro and other foreign currencies stemming from the widening U.S. trade deficit.

The upcoming rate hike will result in higher interest payments for many consumers and businesses. The standard prime rate, which rises in lockstep with the overnight federal funds rate, will rise to 5 percent, compared with 4 percent in June.

Long-term mortgage rates, however, actually have moved down since June because of concerns about the economy’s slowdown.

With the economy expanding steadily, the Fed is raising rates at what officials describe as  a “measured” pace to keep a lid on inflation.

But despite Friday’s strong jobs report, the economy seems in little danger of overheating anytime soon. In fact there are many signs indicating growth is slowing.

The index of Leading Economic Indicators has fallen for four straight months,  factory output fell in September and retail sales have turned soft.

“The leading indicators suggest to me the economy is in the process of moderating — not collapsing, but moderating,” said Paul Kasriel, research director at Northern Trust. He pointed to a slowdown in the growth of the money supply, one of the leading indicators, and what he projected as a “dramatic” slowdown in retail sales that will be seen in reports to be published soon.

David Rosenberg, chief North American economist for Merrill Lynch, found signs of underlying weakness even in the generally positive October jobs report. A wave of hurricanes in August and September clearly contributed to the outsized job gains in October, he noted. Manufacturing jobs declined for a second straight month, and the average workweek was unchanged at 33.8 hours.

“Right now, unless we see some improvement in the leading indicators, the Fed is going to go into a multimonth freeze at some point pretty soon,” Kasriel said.

Other analysts agree with that assessment, but nobody knows just when the Fed will be ready to pause. Financial market participants generally expect Fed policy-makers to raise short-term rates another quarter-point at their final policy-making session of the year Dec. 14, although Rosenberg, for one, disagrees.

Central bankers presumably are trying to push their benchmark rates to a “neutral” area some point above the rate of inflation. But in a widely noted speech last month, San Francisco Fed President Janet Yellen suggested the Fed’s policy-making Open Market Committee could pause at some “intermediate” level that would continue to promote growth to full employment.

“There might be a need to consider pausing in the process of raising rates if slower growth in demand caused economic activity or labor market activity to slow down,” or if inflation rates were to fall much further, Yellen said in the speech.

Some analysts also speculate that Greenspan would like to finish hiking rates soon to set the Fed on a steady path ahead of his scheduled retirement in early 2006. “Who needs to risk a financial accident months before retirement?” Rosenberg asked in a note.