The Federal Reserve is likely to lift key rates by a quarter-point this week, but a sputtering US economy is forcing policymakers to re-evaluate the outlook for future increases, analysts say.
Based on signals from central bank officials, economists say the Fed is almost certain to make its third rate hike since June 30, boosting the federal funds rate to 1.75 percent.
But observers say Fed chairman Alan Greenspan and his colleagues, who have pledged a "measured" effort to bring up interest rates from their lowest levels in decades, must think hard before taking base rates up much higher.
Greenspan has argued that the economy is gaining traction after a "soft patch," but some argue that the recovery is still fragile and could be choked off by a number of factors, including higher rates.
"We have a Fed that is still bent on raising rates Sept. 21, if for no other reason than to normalize interest rates," said David Rosenberg, chief North American economist at Merrill Lynch.
But Rosenberg said that with inflation low and many indicators from retail sales to industrial output lackluster, there is no compelling reason to aggressively move rates higher.
"In terms of whether the soft patch is over, I think it's a little premature to make that proclamation," he said. "I think the most you can say is that things are not getting worse."
Leslie Preston at CIBC World Markets said the tame inflation figures may illustrate economic weakness -- businesses cannot raise prices because of sluggish demand and consumers who are tapped out.
"Widespread discounting in a number of sectors also reinforces our view that the economy may not be emerging from its soft patch as quickly and strongly as Greenspan and some observers have recently been suggesting," Preston said in a note to clients, citing steep cuts in the prices of cars and apparel to move the merchandise.
"Greenspan has not deviated from his story that the current soft patch is temporary, and a 25-basis-point hike [tomorrow] is likely a done deal. But as the squeeze on retailers spreads through the economy, the Fed will eventually be forced to take a long pause on its rate-hike agenda."
Ironically, some observers say the Fed's signal has forced the central bank into a position where it must increase rates or acknowledge that the economy is weak, possibly setting off panic.
"The Fed has made clear that the tightening is not over. In an election period, they do not want to call attention to themselves by surprising the markets [with either language or rate changes] at the meeting," said Ethan Harris, economist at Lehman Brothers.
"Thus, we expect a 25-basis-point hike with one minor change in the text, acknowledging that `recent inflation data have been more contained.'"
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