Fed halt in rates is likely today

Policymakers to weigh risks of inflation with threat of recession

August 08, 2006|By MCCLATCHY-TRIBUNE

WASHINGTON -- The Federal Reserve is expected to pause today after 17 consecutive interest-rate increases, ending a streak of credit tightening that has lifted short-term lending rates from 1 percent to 5.25 percent since June 2004.

Still, analysts warn that the Fed may raise rates in the months ahead if signs persist that inflation is growing worse. Countering that threat, however, is the risk that further rate increases could tip the slowing economy into recession.

As the Fed's rate-setting Open Market Committee weighs the competing risks today, it is expected to pause to buy time for more data to accumulate and show which risk is more threatening.

"They have to weigh the risks of tightening again and doing too much and really hurting the economy, or waiting and risk that inflation climbs a bit higher," said Nigel Gault, chief U.S. economist for Global Insight, a consultant in Lexington, Mass. "They don't have to decide whether interest rates have peaked."

The Fed decision today concerns the federal funds rate, which banks charge each other for overnight loans. That's a benchmark rate for bank loans to consumers and businesses.

Raising interest rates makes borrowing money costlier and slows economic activity. That is sometimes necessary to take the steam out of inflation - the rise of prices across the economy - but it also puts financial stress on consumers and businesses, and it costs jobs.

Because it can take six months or more before a rate increase's effect is felt across the economy, the Fed often is uncertain when to stop raising rates.

Tighten credit too much and the economy can slip into recession.

But if it fails to tighten enough, inflation can get out of control, distorting economic decisions and forcing much higher rate increases later to subdue it.

Fighting inflation is the Fed's chief mission, and just about every measure of inflation is running higher than is thought to be the Fed's comfort zone. The core inflation rate tied an 11-year-high in June at 2.4 percent.

Soaring energy prices and high commodity prices are driving the current bout of inflation, and wage and benefit costs are rising worrisomely fast as well.

The inflation risk from energy costs continues to grow. British Petroleum shut down an Alaska pipeline Sunday that pumps 8 percent of daily U.S. oil production. BP said the pipe may be shut for months to repair corrosion. That sent crude oil prices up about $2 a barrel to $76.98 per gallon on the New York Mercantile Exchange. Gasoline pump prices could jump another dime this week.

In addition, the heart of hurricane season is only weeks away, threatening oil production in the Gulf of Mexico.

But many investors are betting that the slowing economy will make the Fed pause. The U.S. economy grew at only a 2.5 percent annual rate in the second quarter, sharply slower than the previous quarter's 5.6 percent rate.

The slumping housing sector is largely responsible, as new-home starts, existing-home sales and home-equity loans all declined. Rising interest rates hurt all three.

The job market is hurting, too. Non-farm payroll jobs grew by just 113,000 in July, well below expectations, as the unemployment rate rose to 4.8 percent from 4.6 percent in June.

"When you combine all the economic indicators out there ... one conclusion is clear. The economic expansion is noticeably winding down. We believe so will inflation," wrote Bernard Baumohl, executive director of the Economic Outlook Group, a consultant in Princeton, N.J., in a note to investors. "The right decision for the Fed now would be to pause at this juncture at 5.25 percent."

The Fed's next decision on rates will come Sept. 18, and troubling wage trends may influence it. Real average weekly earning rose 0.6 percent from May to June.

"Faster labor cost growth makes it harder for firms to hold prices stable, putting upward pressure on inflation," researchers at Goldman Sachs & Co. warned Friday.

The Labor Department is to issue new labor and productivity data today.

"Even as the Fed is pausing, they may also be seeing some more labor-cost inflation," said Phillip Neuhart, an analyst with Wachovia, a banking giant based in Charlotte, N.C.

" ... One of the reasons they would leave the door open is fear of wage inflation."

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