Investors await Fed decision on rates

Analysts believe Alan Greenspan wants to raisie interest rates incrementally before he steps down in January 2006.
Analysts believe Alan Greenspan wants to raisie interest rates incrementally before he steps down in January 2006.AP Photo
/ Source: The Associated Press

Federal Reserve Chairman Alan Greenspan and his colleagues appear ready to kick off 2005 the way they ended 2004 _ continuing a series of modest interest rate increases to make sure inflation stays in check.

Fed policy-makers were wrapping up their first meeting of the new year on Wednesday. It was widely expected that at the end of the two days of discussions the central bank will announce another quarter-point increase in the federal funds rate.

That would be the sixth quarter-point increase in the funds rate, the interest that banks charge each other, since the first move last June when it had been at a 46-year low of 1 percent.

The funds rate now stands at 2.25 percent. Many analysts believe it will be heading higher throughout 2005, Greenspan's 18th and final year at the helm of the central bank.

The Fed's goal is to move the funds rate from an accommodative stance, where it is still stimulating extra economic growth, to a neutral stance where the funds rate is neither stimulating growth nor holding the economy back.

"The Fed is taking its foot off the accelerator without hitting the brakes," said Richard DeKaser, chairman of an American Bankers Association panel of economists that meets twice a year with Fed policy-makers to give them their views of where the economy is headed.

There is debate in economic circles about where the neutral level is, but many economists believe it is somewhere between 3.5 percent and 4.5 percent for the federal funds rate.

If the Fed keeps increasing rates by a quarter-point at each of the eight scheduled meetings this year, the funds rate would be at 4.25 percent at the end of this year, a level where many analysts believe Greenspan will feel good about stepping down in January 2006 when his term as a Fed board member ends.

"I think Greenspan really would like to leave his successor with no work to do," said David Wyss, chief economist at Standard & Poor's in New York.

But Wyss and other economists believe the pace of the Fed's credit increases will depend on how the economy performs.

If, as expected, overall economic growth slows this year to around 3.5 percent, down from 4.4 percent last year, and inflation moderates as energy prices retreat, analysts believe the central bank will stay with its gradual quarter-point moves.

However, if oil prices do not moderate or if the economy grows at a faster pace than expected, putting upward pressure on prices, then analysts said the central bank will probably accelerate its rate increases.

Financial markets became worried about the possibility of a more aggressive Fed stance in early January when a reading of the minutes of the Fed's Dec. 14 meeting seemed to indicate growing worries about inflation inside the Fed.

But in recent weeks various Fed officials have given speeches in which they have gone out of their way to stress that they do not believe inflation is getting out of hand.

"The Fed doesn't want to rock the boat or alarm anybody," said Sung Won Sohn, chief economist and head of Hanmi Bank in Los Angeles.

Economists are split on how high interest rates will go. Some believe the funds rate will end the year at 4.25 percent while others think if inflation pressures remain contained, the Fed may skip raising rates for a meeting or two.

David Jones, head of DMJ Advisors, said he looks for the Fed to raise rates by a quarter-point at each of the next three meetings but then pause with the funds rate at 3 percent to see what impact these rates increases are having on the economy.

With the movement in the funds rate, other interest rates will be rising as well. The prime lending rate, banks' benchmark for millions of consumer and business loans, now stands at 5.25 percent, up from 4 percent last June before the Fed rate increases began. That had been the lowest level for the prime since late 1958.

The prime moves in lockstep with the funds rate so each quarter-point increase in the Fed rate will push the prime up by another quarter point.

Analysts are looking for mortgage rates, which are set by financial markets, to rise as well, but not by as much as short-term rates go up. Many analysts believe the 30-year mortgage rate, which stands at 5.66 percent, could rise by a little less than 1 percentage point to around 6.5 percent by the end of the year.