Originally created 02/02/05

Fed expected to increase interest rates

WASHINGTON - Federal Reserve policy-makers are likely to keep bumping up short-term interest rates this year, a defense against an inflation flare-up now that the economic expansion is on firm footing.

The Fed is expected to boost its key federal funds rate by one-quarter point to 2.50 percent Wednesday. The policy-makers, in their first gathering of 2005, opened a two-day meeting Tuesday.

For now, economists are predicting Fed Chairman Alan Greenspan and his colleagues will stick to their approach of gradually raising interest rates in the months ahead. Thus far, there's been no reason to veer off that path - either by speeding up or slowing down the rate-raising campaign.

That campaign, which started in June 2004, has resulted in five, one-quarter point increases in the federal funds rate, which now stands at 2.25 percent.

The funds rate, the interest banks charge each other on overnight loans, is the Fed's primary tool for influencing the economy. Before the Fed started to push rates up in June, the funds rate stood at a 46-year low of 1 percent.

The extraordinarily low funds rate had been used to help shore up the economy, which had been struggling to get back to full throttle after being knocked by the 2001 recession and terror attacks. With the economic expansion more deeply rooted, the Fed needs to move the funds rate to a more normal level so all the cheap money doesn't sow the seeds of inflation.

"You could call this the no-surprises Fed," said Carl Tannenbaum, chief economist at LaSalle Bank. "A continuation of the one-quarter percentage point increments is in the offing. They will assess as they go each step."

Tannenbaum and other economists believe the Fed will maintain its current stance that further interest rate increase can be "at a pace that is likely to be measured."

A quarter-point increase in the funds rate would mean that commercial banks' prime lending rate used for many short-term consumer and business loans, would climb to 5.50 percent, from the current 5.25 percent. The prime rate moves in lockstep with the funds rate.

Even with the Fed's string of rate increases, longer-term interest rates, such as mortgage rates, have been well behaved, in part reflecting investors' confidence that the Fed is on top of inflation. Rates on 30-year mortgages fell last week to 5.66 percent, marking the fourth week in a row that these rates declined.

For all 2004, consumer prices rose 3.3 percent, the most since 2000. Much of that pickup reflecting surging energy prices.

Excluding energy and food costs, "core" prices increased by 2.2 percent last year. While core prices were up considerably compared with the 1.1 percent increase registered in 2003, they are still considered relatively low by historical standards, analysts say.

"The economy seems to be on a well balanced track. We've had good growth on the consumer and business side and inflation is not worrisome," said Lynn Reaser, chief economist at Banc of America Capital Management.

The economy finished 2004 with its best performance in five years despite slowing in the final stretch. Economic growth clocked a 4.4 percent increase for all of last year spurred by brisk consumer and business spending.

In the October-to-December quarter, however, the economy grew at a 3.1 percent annual rate, its most sluggish pace since the first quarter of 2003. That deceleration reflected a drag on growth from the nation's bloated trade deficit.

Still, the outlook for 2005 is good, with economists predicting the economy will grow by 3.5 percent or more. That would be sufficient to spur modest - not spectacular - job growth in the months ahead, analysts said. The nation's payrolls in 2004 expanded by 2.2 million, the first annual increase in three years.

Some economists believe the Fed wants to push up the funds rate to around 3.50 percent this year. Others think the fund rate will end up around 4 percent. Either figure, analysts said, would be relatively neutral, meaning it would neither slow nor stimulate economic activity.

On the Net:

Federal Reserve: http://www.federalreserve.gov/


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