Mon, May 08, 2006 page10

• US interest rate debate heats up

  PAUSE, OR NOT? While most economists say it's 'virtually certain' the US Fed will increase rates this week, they are less sure about the direction it will take after that

  • AFP
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  The Federal Reserve is guaranteed to raise US interest rates this week, economists believe, but debate about where it will go next is reaching fever pitch.

  The US central bank's Federal Open Market Committee (FOMC) meets on Wednesday and is expected to stage the 16th consecutive hike to US rates. That would take the benchmark rate up a quarter point to 5 percent.

  "Another rate hike is virtually certain, so the markets will focus on how the directive characterizes the outlook for policy in the coming meetings," Lehman Brothers economists said.

  Wall Street's hopes of an imminent pause to the Fed's long campaign of hikes, which began in mid-2004, have soared since Chairman Ben Bernanke last month hinted at an end "at some point in the future."

  Investors decided that point would come sooner rather than later, despite Bernanke's reported complaint to a television anchorwoman that the markets had taken a far too rosy view of his remarks.

  Any decision to pause "does not preclude actions at subsequent meetings," and the Fed "will not hesitate to act," if necessary, to keep inflation in check, Bernanke stressed in congressional testimony last month.

  But on Friday, US shares powered close to all-time highs after weak jobs growth last month raised hopes for a Fed pause even higher.

  The Dow Jones share average rocketed 138.88 points (1.21 percent) to close at a six-year high of 11,577.74. The blue-chip index is not far off its all-time closing high of 11,722.98 reached in January 2000.

  The rally came after the US Labor Department's non-farm payrolls report showed that US employers added a weaker-than-expected 138,000 new jobs last month, the worst level since October.

  But on a less positive note for interest rates heading into the FOMC meeting, the payrolls report also showed a sharp rise in wages.

  Average hourly earnings increased US$0.09, or 0.5 percent, to US$16.61 last month, the Labor Department said. Earnings are up 3.8 percent in the past year, the biggest year-over-year gain since August 2001.

  "Suffice it to say that the Fed will have to balance the modest job growth revealed in this report with the accelerating pace of wage growth," said Eric Lascelles, currency and fixed-income strategist at TD Securities.

  "It seems fairly safe to assume that the Fed will hike rates by 25 basis points to 5.0 percent next Wednesday, but the jury remains out for any decision after that, in light of Bernanke's unclear comments last week and the latest string of economic data," he said.

  Until recently, record-breaking oil prices had failed to have much effect on consumer prices in the US. Neither have US workers derived much benefit in their pay packets from robust growth.

  That appears now to be changing, with more and more businesses saying they are having to pass higher commodity costs on to their customers.

  "In-phase world growth, where just about every part of the world is now expanding, is putting pressure on commodity prices, not just oil," said Joel Naroff at Naroff Economic Advisors.

  "With labor costs rising, Mr Bernanke has to be worried that this could lead to higher inflation," he said.

  But against that, Bernanke's Fed is keen not to take US rates so high that they kill the economy.

  The chairman believes that after registering a blistering growth pace of 4.8 percent in the January-March quarter, the US economy is set to soften naturally, particularly as the red-hot property market cools.

  "Based on the information in hand, it seems reasonable to expect that economic growth will moderate toward a more sustainable pace as the year progresses," Bernanke told the US Congress on April 27.

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