US Fed expected to hike interest rates

CONSENSUS VIEW: Analysts are betting on an interest rate hike to 3 percent as the US central bank continues to stave off inflation, despite signs that growth is sluggish


Mon, May 02, 2005 - Page 12

The Federal Reserve is expected to raise US interest rates again tomorrow to quell inflationary pressures in the world's biggest economy, despite evidence of slowing growth.

The Federal Open Market Committee, the US central bank's policy-making forum, meets under the chairmanship of Alan Greenspan tomorrow with analysts betting it will lift rates by 25 basis points to 3.0 percent.

Merrill Lynch senior economist Sheryl King said the Fed's eighth successive hike was "virtually a done deal."

"In spite of the stream of weak economic data that shows the economy is losing steam, the Fed will bump rates up another 25 basis points," she said.

"Apart from some indication that the US economy has hit a soft patch, the tone from the Fed will be largely unchanged, in our view."

The tone adopted in FOMC statements has, for a year, been to stress the Fed's preference for "measured" increases in US borrowing costs.

Consumer prices and other inflationary indicators have all been going up on the back of high oil prices, reinforcing the FOMC's view expressed at its last meeting on March 22 that "pricing power is more evident."

But since the late March meeting, evidence has also accumulated that the US economy is flagging somewhat. With price pressures still a threat, that has led some commentators to fear a return to 1970s-style "stagflation."

After a slew of poor numbers for retail sales, trade and housing construction, the government said Thursday that gross domestic product growth eased to 3.1 percent in the first quarter, its slowest rate in two years.

While still pretty robust by comparison with its trading partners, the US economy is starting to feel the heat from high oil prices, which are hurting many companies' bottom lines and sending petrol-pump prices to new peaks.

With the state of the energy markets encouraging the Fed to stay hawkish on inflation, the growth figures may give Greenspan and his team some pause for thought, analysts believe.

"There's definitely a deceleration under way, and the question is what will be the length of this soft spot," John Lonski at Moody's Investors Service said after the GDP report was released.

"The Fed will probably decide against tightening more aggressively in deference to the slower rate of domestic spending," he said.

"If it pauses, it will be because of unforeseen weakness in term of employment growth."

On the other hand, the Fed may well point to other figures released Friday that showed US consumer spending and personal incomes both rising by more than expected in March.

"As for the Fed, the modest increases in compensation allow the FOMC to continue to raise rates at a 'measured' pace, even if that phrase does come out of the statement," Joel Naroff of Naroff Economic Advisors said.

"Until there are signs that wage gains are picking up, the Fed does not need to increase rates more than 25 basis points at a meeting," he said.

For Fed watchers, the most interesting aspect of tomorrow's meeting could be whether the year-old language about "measured" hikes disappears.

But with overall economic prospects looking clouded, the FOMC has much to ponder as it debates its longer-term stance on monetary policy.