Oil prices are surging and wages are growing at the fastest clip in a year, reasons enough for the Federal Reserve to keep pushing interest rates higher the rest of the year and probably well into 2006 in an effort to keep inflation in check.
The Fed is expected to raise short-term rates a quarter-point on Tuesday, the 10th increase starting in June of last year.
Despite that long campaign to tighten credit, rates still are too low, Federal Reserve Chairman Alan Greenspan and his colleagues have suggested.
“The Fed has much more work to do in tightening interest rates,” said Mark Zandi, chief economist at Economy.com.
“We will see bigger pay increases going forward, and businesses will try to defend their profit margins by raising their prices more aggressively,” Zandi predicted. “So I do think market pressures are developing that signal stronger inflation ahead.”
Fighting inflation is job No. 1 at the Fed. It has boosted a key rate, called the federal funds rate, by one-quarter percentage point nine times starting on June 30, 2004. A 10th increase on Tuesday would lift the funds rate, the interest that banks charge each other on overnight loans, to 3.50 percent.
In response, commercial banks are expected to boost their prime lending rate, used for many short-term consumer loans, by a corresponding amount, to 6.50 percent.
If the expected increases take place, both the prime rate and the funds rate would be the highest since Aug. 21, 2001.
Some economists believe the funds rate could rise to 4.25 percent by the end of this year. That would push the prime rate to 7.25 percent.
But Fed policy-makers, at their last meeting in late June, disagreed on how high the funds rate must be to keep inflation and the economy on an even keel.
“Additional tightening would probably be necessary but views differed on the amount of tightening that would likely be required to keep inflation contained,” minutes of the Fed’s June 29-30 meeting revealed.
Greenspan, delivering the Fed’s midyear economic report to Congress last month, said the outlook for both the economy and inflation was good.
But he cautioned that a big run up in already high energy prices could throw a wrench in the outlook. He also said policy-makers needed to keep an especially close eye out for signs of inflation from labor costs.
Oil prices soar to record high
Since Greenspan’s congressional appearance, oil prices have marched upward. They shot up to a new record Monday, closing at a high of $63.94 a barrel, surpassing the previous high reached Friday. And the job market has gotten stronger.
The government reported last week that employers, in a summertime show of confidence in the economy’s staying power, added 207,000 jobs in July. Employees’ average hourly earnings rose to $16.13 in July, a 0.4 percent increase from the previous month— the most in a year.
“This certainly raises the possibility the Fed will remain in play for a longer period — well into 2006 — if these trends continue,” said Anthony Chan, senior economist at JP Morgan Asset Management.
Wage growth is good for workers and it also is the fuel for future spending by consumers, a key ingredient in the country’s economic health. But big wage increases — if sustained month after month — can fan inflation, particularly if productivity growth slows.
Inflation at the consumer level, as measured by the consumer price index, was well behaved in May and June. But the surge in oil prices in early July and then again in August could intensify inflation pressures, economists said.
So far, high energy prices aren’t hurting economic growth. The economy expanded at a chipper 3.4 percent pace in the second quarter and is expected to top a 4 percent pace in the July-to-September period.
Some economists also believe the Fed will keep raising rates tamp down any inflation forces from the booming housing market, where home prices has risen sharply in some local markets. Greenspan has expressed heightened concern about “speculative fervor.” Before the Fed embarked on its rate-raising campaign, the prime rate stood at 4 percent, the lowest since 1958; the funds rate was at 1 percent, a 46-year low.
Rates had sunk to those low levels after an aggressive series of rate cuts to help the economy recover from the 2001 recession and the jolt of the Sept. 11, 2001, terror attacks and a wave of corporate accounting scandals that rocked Wall Street.