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Mon, Jun 28, 2004 - Page 12 News List

US interest rates to be raised this week

DIFFICULT TERRAIN The Federal Reserve, in a bid to kill inflation without murdering the economy, is expected to raise the federal funds rate by 0.25 percentage points


US Federal Reserve Chairman Alan Greenspan tells the Joint Economic Committee on Capitol Hill that America's economic recovery has good momentum and that low, short-term interest rates will have to rise at some point.


The US will raise interest rates for the first time since 2000 this week, embarking on a treacherous bid to kill inflation without murdering the economy, analysts said.

The Federal Reserve is universally expected to raise the federal funds target rate -- now a near-rock-bottom 1.0 percent, the lowest since 1958 -- by 0.25 percentage points, they said.

The decision, to be announced at about 2:15pm on Wednesday after a two-day meeting, will mark a U-turn.

Since January 2001, Federal Reserve chairman Alan Greenspan has been cutting rates to cushion the economy from successive shocks: The popping of the technology bubble in the late 1990s, the Sept. 11, 2001 terrorist attacks, corporate scandals and the wars in Afghanistan and Iraq.

Now policymakers must switch direction to beat back inflation pressures fuelled by super-heated oil prices and a feeling that consumers, finally, are prepared to pay more.

"The conditions are in place for the Fed to begin withdrawal of its extraordinary accommodation," said Citigroup economist Kermit Schoenholtz.

"The key issue is how rapidly the Fed will need to tighten."

By the end of 2005, the Federal Open Market Committee is widely expected to have roughly quadrupled the key rate to 4.0 percent, probably boosting by a quarter point in 12 straight meetings.

"The Fed's forthcoming rate hikes will be more akin to Alan Greenspan taking his foot gradually off of the monetary accelerator as opposed to Mr. Greenspan pressing hard on the monetary brake," Moody's Investors Service chief economist John Lonski said.

Greenspan is desperate to avoid a repeat of 1994, when the Federal Reserve pushed the interest rate to 6 percent from 3 percent in a year, a shock blamed for almost melting the mortgage market, sending Orange County, California into bankruptcy and triggering the ensuing Mexican peso crisis.

Concerns are exacerbated by the delicate political climate, with US President George W. Bush fighting for re-election on Nov. 2.

To avoid a repeat shock, Greenspan has delivered a series of speeches all but announcing the fact that rates are going up on June 30.

"Officials have highlighted their willingness to act aggressively if price pressures unexpectedly intensify, but market fears of a Fed panic have been overdone," Schoenholtz said.

Two developments opened the path to a return to normalcy in interest rates: The end of a three-year jobs drought marked by the creation of nearly a million jobs in the past three months and the defeat of the menace of deflation with underlying prices on the rise.

Still, risks remain.

In particular, rising rates could stall the housing market, where low rates put an estimated US$410 billion into the pockets of homeowners last year in a mortgage refinancing frenzy.

"Even anticipated Fed tightening is sapping a key source of consumer funding," CIBC World Markets economists Benjamin Tal, Avery Shenfeld and Leslie Preston said in a report.

"Further increases in long-term rates and subsequent softening in the red-hot housing market will bring the refinancing gravy train to a complete halt," they warned.

In the first four months of 2004, half of new mortgages were on adjustable rates, exposing borrowers to a harsher climate, CIBC said.

"While many could pay the higher rates, a rising number of Americans are living on the edge of a debt precipice, where it would not take a large push to knock them into default."

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