Fed is expected to continue `measured' rate rises in 2005

With inflation low, another quarter-point increase is likely today


WASHINGTON - Despite new evidence that economic growth has slowed in recent months, the Federal Reserve appears poised to continue raising interest rates for most if not all of this year.

Analysts almost unanimously predict that the Fed will increase rates today by another quarter-point, to 2.5 percent, and most expect the central bank to repeat past statements about raising rates at a "measured" pace.

Economic trends suggest that policy-makers have no reason to slow or accelerate the rate increases soon.

Inflation, though subdued by most measures, is running higher than a year ago. Strong oil prices and a weaker dollar push up the cost of imports, and many analysts have predicted that the soaring trade deficit will cause the dollar to fall further this year.

But in a series of recent speeches and public comments, Fed officials have placed more emphasis on their view that growth will probably remain fairly strong this year and that the economy does not need to be stimulated.

The Commerce Department estimated Friday that the economy grew at an annual rate of 3.1 percent from September through December, much slower than in the previous quarter and less than most forecasters had predicted.

Still, other indicators point to steady if not spectacular growth of about 3.5 percent this year, which would be the fourth consecutive year of an expansion.

Yesterday, the Institute for Supply Management said factory activity increased for a 20th consecutive month in January, but the pace of expansion eased, reflecting sustained, moderate economic growth.

One significant reason for the Fed to keep lifting short-term rates, analysts said, is that cheap money is almost as plentiful now as it was before the Fed started the process six months ago.

Mortgages decline

Although short-term interest rates have been nudged up five times since June, to 2.25 percent from 1 percent, the cost of home mortgages and long-term corporate financing has declined.

Rates on 10-year Treasury bonds, which directly affect home mortgage rates, have been about 4.13 percent, lower than they were in June, before the central bank first raised the federal funds rate on overnight loans between banks.

The persistence of low long-term rates has kept the nation's housing market hotter than most forecasters had expected, and it has also made it easy for companies to raise money at low cost for expansion or acquisitions.

Greater confidence

Analysts said an increase in big mergers and acquisitions, such as Procter & Gamble Co.'s plan to acquire Gillette Co. for $54 billion and SBC Communications Inc.'s planned $16 billion purchase of AT&T Corp., points to a greater confidence among companies, illustrated by their willingness to take risks.

"Monetary tightening has not yet had an effect on the economy," said David D. Hale, an independent economist in Chicago. "Credit spreads are tight; mortgage rates are low."

The Federal Reserve caused shivers among investors and analysts last month when it released notes from its December policy meeting, in which some officials were said to worry about "speculative excesses" and inflationary pressures.

But a number of Fed officials have publicly played down those concerns. "I disagree with the view that low interest rates promote a sort of moral hazard in financial markets," Ben S. Bernanke, a Fed governor, said Jan. 19.

Janet Yellen, president of the Federal Reserve Bank of San Francisco, expressed a similar skepticism about the risks of excess speculation, as have at least four other senior officials.

Minutes from previous Fed meetings have made it clear that a minority of officials on the Federal Open Market Committee, which sets the federal funds rate, would like to abandon the implied pledge to raise rates at a "pace that is likely to be measured."

Critics of the reference to a measured pace contend that it locks the central bank into future decisions. But the Fed is expected to keep the phrase for at least another month, along with its assessment that the upside and downside risks of inflation and growth are balanced.

Even at 2.5 percent, the funds rate would be higher than the core rate of inflation, which excludes the costs of energy and food. But it would still be lower than last year's overall increase in consumer prices.

"There is definitely a recognition that we need to get to a different setting, and the only question is how fast to go," said Robert V. DiClemente, a senior economist at Citigroup. "The inflation outlook is manageable, as long as we keep moving."

Based on the prices of federal-funds futures contracts, which are bets on the outlook for the funds rate, investors almost unanimously expect overnight rates to climb to about 3.5 percent by the end of the year.

Many analysts said the Fed will probably raise rates at every policy meeting this year, which could push the overnight rate up to 4 percent.

`Lowballing' the Fed

"I think the market is low-balling what the Fed is likely to do," said Lyle Gramley, a former Fed governor and now an adviser to the Washington Research Group.

Gramley said investors had focused on the likelihood of slower economic growth this year and were betting that the central bank would feel less need to cool down an overheated economy.

But he said it was possible to have slower growth and inflationary pressures at the same time.

"This will be Greenspan's last year," Gramley said, noting that the Fed chairman's term as a governor will end in January and cannot be renewed.

"He's going to be thinking about his legacy, and he doesn't want that legacy to be higher inflation."

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