Originally created 05/18/99

Interest rates may rise soon



WASHINGTON -- Americans, who have grown accustomed to nothing but good news on inflation, got a jolt last week when consumer prices jumped by the largest amount in nearly nine years, led by a sharp increase in gasoline prices.

That development will not be on the table when Federal Reserve policy-makers meet today, but private economists say it will take more than one bad number to prompt the central bank to start raising interest rates.

These analysts, however, said they expect the Fed to start raising interest rates later this year, probably at the policy-makers' August meeting, to slow the economy and keep inflation from becoming uncontrollable.

"The countdown is really on for a future tightening move by the Fed," David Jones, chief economist at Aubrey G. Lanston & Co. in New York, said Monday. "It is no longer a matter of whether they will tighten, but when."

The central bank last changed rates in fall 1998 when the federal funds rate, the interest that banks charge on overnight loans, was cut three times to help restore investor confidence and avert a worldwide recession. The funds rate has been at 4.75 percent since Nov. 17.

The rate cuts worked. U.S. markets have since returned to record levels, bolstered by low U.S. interest rates and continued strength in a U.S. economy enjoying its lowest unemployment levels in three decades.

But since Friday's bad inflation report, Wall Street has grown nervous. The yield on Treasury's benchmark 30-year bond moved back toward 6 percent, the highest level in a year. The Dow Jones industrial average, which hit a record high Thursday, has fallen sharply.

"The best news on inflation is over," said Allen Sinai, chief economist at Primark Global Economics. "That is not to say that we will have runaway inflation, but we have seen the lows on inflation."

Few private economists expect a Fed rate increase Tuesday, but some said the central bank may employ a new signaling device to put financial markets on notice about the future direction of interest rates.

Up until now, the central bank only announced actual rate changes after meetings of its Federal Open Market Committee, composed of Fed governors and bank presidents who gather eight times a year to set interest rates.

However, at its December meeting, the Fed approved a change in policy that would allow it to signal the future direction of rates by allowing it to reveal changes in its policy directive.

Since the series of three easing moves, the Fed has been in a neutral stance, meaning both a rate cut and rate increase were likely. Many analysts expect the central bank to announce Tuesday that it has changed its policy directive from neutral to leaning toward raising rates.

That announcement alone will likely push rates set by financial markets upward because it would confirm their suspicions that the central bank is leaning toward a future rate hike.

Sung Won Sohn, chief economist at Wells Fargo & Co. in Minneapolis, said a policy directive change would nudge market rates in the direction the Fed wants. It also would give Federal Reserve Chairman Alan Greenspan more time to prepare for a Fed rate hike.

"If Greenspan were to raise rates Tuesday, I think a lot of politicians would squawk," Sohn said. "At this point, it would be very difficult politically and economically to justify hiking interest rates."

While consumer prices were up in April, other recent reports showed that wage pressures remain low despite the tight labor markets. The April report of wholesale prices showed little inflation pressures in the pipeline.

Many economists believe that the Fed will wait until its Aug. 24 meeting to actually increase rates, although some said the rate increase could come as soon at the June 29-30 meeting if the CPI remain high.

The Clinton administration continued to insist Monday that despite inflation jitters, the U.S. economy remains on solid ground.

"I think if you look forward, the most likely prospect remains solid growth, low inflation," said outgoing Treasury Secretary Robert Rubin.