ICS Magazine

Interest Rates Set to Rise, Ending an Era

June 30, 2004
WASHINGTON (Reuters) - U.S. central bank policy-makers were set to pull the plug on Wednesday on the cheapest credit in decades by raising official interest rates for the first time in four years.

Analysts universally expect the Federal Reserve's policy-setting Federal Open Market Committee to move up the federal funds rate a quarter percentage point from its current 1 percent, which is its lowest since 1958.

The FOMC meeting is a two-day event to prepare for congressional testimony next month by Fed Chairman Alan Greenspan. It began on Tuesday afternoon and resumed at 9 a.m. EDT (1300 GMT) on Wednesday morning. A decision on rates is expected to be announced at about 2:15 p.m. EDT (1815 GMT).

If there is scant suspense about the rate move, interest in the Fed's post-meeting statement is running high.

Wall Street players will comb through the statement, examining each carefully chosen word for any change to the Fed's intention to keep further rate rises gradual, or "measured" -- language taken to mean a series of quarter-percentage point increases rather than half percentage point or larger.

Analysts expect policy-makers to reserve room for a faster pace of future increases should wage or price inflation heat up, something they would indicate in the rates statement.

"I think they're going to try to get some flexibility so that if inflation increases or the economy accelerates beyond what the Federal Reserve is expecting, they'll be able to move a little bit more aggressively," said economist Anthony Chan of Banc One in Columbus, Ohio.

Fed Chairman Alan Greenspan said in London at the beginning of the month the central bank was ready to "do what is required" to stem any upsurge in price pressures.

With the economy growing smartly -- fast enough to generate 1.2 million new jobs this year -- there is some worry that prices and wages could begin accelerating at a pace that forces the Fed to play "catch-up" by pushing rates up sharply.

Some economists see energy cost rises as temporary and believe booming overseas economies like China's will slow and reduce price pressure on commodities.

However, there is also some concern that the U.S. economy may be on a growth course that will sow its own inflationary seeds by stimulating wage and price rises.

"My own personal view is that there's more to it than one-time increases and we are in the grip of cyclical forces that are boosting inflation," said Dick Berner, chief economist at Morgan Stanley and Co. Inc.

Berner also heads the influential Bond Market Association's economic advisory committee, which issued its mid-year review on Tuesday saying it expected the fed funds rate to reach 2 percent by the end of this year and 3 percent by mid-2005.

Those levels are moderate by historical standards -- the fed funds rate was at 6.5 percent before the easing cycle that began in 2001 and culminated in a cut to 1 percent a year ago.

Plus, higher rates have largely been "priced into" markets already so they should not come as a shock to consumers and businesses. Fed officials have taken pains to say they see no reason to repeat the rapid tightening cycle of 1994. Rates have already risen in bond and other markets in anticipation of the Fed's action and Bush administration officials have played down any possibility they will dampen a burgeoning recovery.