Federal Reserve Chairman Alan Greenspan and his colleagues are being buffeted by strong economic crosscurrents — rising inflation pressures on one hand and a sudden slowing in economic growth on the other.
Faced with conflicting forces, the Fed is still expected to stay the course, raising interest rates by a moderate quarter-point on Tuesday, the eighth such increase since the central bank embarked on the current credit-tightening campaign last June.
“There is certainly not going to be any surprise in their action. Every indication is that the Fed will hike the federal funds target by another quarter-point,” said David Jones, head of DMJ Advisors.
Such a move would push the target for the funds rate, the interest that banks charge each other on overnight loans, from the current 2.75 percent to 3 percent. When the Fed started boosting rates 10 months ago, the funds rate stood at 1 percent, the lowest level in 46 years.
The increase in the funds rate is expected to trigger a corresponding quarter-point increase in banks’ prime lending rate, the benchmark for millions of business and consumer loans. The prime rate now stands at 5.75 percent.
Analysts believe that given the current economic uncertainty, the Fed will not only stick to another quarter-point rate increase but will also make few changes in the wording of the statement announcing the action.
The expectation is that the Fed, as it has been doing for a year, will pledge to make any further rate increases at a “measured” pace, which has come to mean further quarter-point moves.
The steady-as-she-goes prediction is a far cry from the expectations about the Fed’s next moves that were being made immediately after its last meeting on March 22.
At that time, Wall Street began bracing for the Fed to ditch the promise to be measured and jack up rates by a half-point. That fear of more aggressive Fed credit-tightening was fanned by a change of wording in the March Fed statement to acknowledge more worries about inflation.
Since then, however, various indicators showed the economy slowing sharply in March. The government reported last week that this sudden slowdown had dragged down economic growth to a rate of just 3.1 percent in the first three months of the year, the slowest pace in two years.
That slowdown has eased fears for the time being about the Fed becoming more aggressive in its rate hikes. Analysts, however, are not looking for a pause in the gradual quarter-point increases because various inflation statistics are continuing to flash some warning signals.
Consumer prices jumped 0.6 percent, reflecting the surge in energy costs, but even outside of volatile food and energy, the so-called core rate of inflation was up 0.4 percent in March, the biggest jump in 2½ years.
“The pace of inflation is still moderate, but it is not as moderate as it once was,” said David Wyss, chief economist at Standard & Poor’s in New York.
Wyss predicted that the Fed will keep raising the funds rate for the rest of the year, leaving it at 4.25 percent at the last meeting in December, a point where the central bank will feel the funds rate is now at neutral, neither so low as to stimulate economic growth or so high as to depress economic activity.
“I think Greenspan would like to get back to neutral before he leaves the Fed,” Wyss said.
Greenspan, who is in his 18th year as Fed chairman, has said he will step down when his term on the board ends in January 2006. December is expected to be his last meeting.
Long-term interest rates have also swung this year in response to the crosscurrents in economic forces. The benchmark 10-year Treasury note, which rose to 4.63 percent after the Fed’s March meeting because of the central bank’s inflation worries, dipped to 4.19 percent on Monday, reflecting the string of statistics pointing to weaker economic growth.
Because of this decline, analysts believe that mortgage rates, which reflect market forces, are not likely to rise very quickly this year. The 30-year mortgage, which fell to 5.78 percent last week, should rise to only 6.25 percent to 6.5 percent by the end of this year, Jones predicted.