The US Federal Reserve faces a tough decision on interest rates tomorrow as it mulls another interest-rate hike after what may be a major blow to the US economy from Hurricane Katrina.
Most economists and market analysts see the Federal Open Market Committee maintaining its stand with an 11th consecutive quarter-point rate hike, taking the federal funds rate to 3.75 percent, although a few experts are doubting the wisdom of such a move.
"All the bets are on a Fed rate hike," said David Rosenberg, chief North American economist at Merrill Lynch. "Futures are priced 86 percent of the way for a Fed rate hike [tomorrow]."
But Rosenberg argues that a rate hike in the midst of what he called a "deep slowdown" in the US economy could be a mistake and said this "would be the first time the Greenspan Fed raised rates in the immediate aftermath of natural disaster."
Fed chief Alan Greenspan and his colleagues have had little time to analyze the economic impact of the storm and the floods that devastated New Orleans.
But many observers say that the economic impact of Katrina should be temporary and that any hesitancy in the fight against inflation might backfire.
"It will be very difficult to use economic data to justify a pause in rate hikes," said Brian Wesbury at Claymore Research.
"In fact, if the Fed were to pause, the market would take it as a sign that something was terribly wrong with the economy. By hiking rates, the Fed will signal confidence in the post-Katrina economy. We believe this will be taken by the markets as a sign of economic strength."
Ethan Harris and Joseph Abate of Lehman Brothers agreed that there were "compelling" reasons to keep raising rates.
"A pause would set a precedent of the Fed responding to regional events rather than focusing on the national growth and inflation picture," they said in a research note, adding that "bowing to political pressure compromises the Fed's anti-inflation credibility."
Timothy Rogers at Briefing.com said the Fed needs to keep lifting rates to stay ahead of inflation.
"Underlying inflation pressures continue to mount," he said. "The unemployment rate is now below 5.0 percent -- the rate many associate with rising labor-based inflation."
While economists continue to debate what rate would be "neutral" for the economy, Rogers said the Fed may have to go even higher than that: "A policy rate higher than `neutral' may be needed to slow an economy spoiled by low and steady long-term interest rates," he said.
Deutsche Bank economists Peter Hooper and Joseph LaVorgna wrote in a note to clients that the Fed "faces a difficult decision ... but we think it will come down on the side of continuing with its measured pace of rate hikes."
"The Fed has a special responsibility to attend to the goal of price stability, and the reduction of productive capacity caused by Katrina poses some clear inflation risks," they wrote.
Additionally, "The market is pricing in a rate hike at this point, and even households are reconciled to an environment of rising rates over the year ahead. Failure to move at this point might well feed budding inflation fears, pushing long-term rates up more."
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