Interest Rate Hike Unlikely for Now, Say Most Experts

Although the Federal Reserve is not yet convinced that the economy is slowing, central bankers will likely leave interest rates unchanged at their policy meeting this week while warning of inflation risks ahead.

Wall Street economists expect Fed Chairman Alan Greenspan and the other Fed policymakers to sit on their hands at the Federal Open Market Committee meeting Tuesday and Wednesday. But many think it is too soon for the Fed to declare victory in the battle against inflation.

The Fed has already raised short-term rates six times over the last year, but most leading Wall Street firms polled by Reuters last week predicted that it would increase borrowing costs again in August.

“I think the Fed will wait and see if they’ve done enough,” said David Wyss, chief economist at Standard & Poor’s. “There is a lot of tightening still in the pipeline.”

There is mounting evidence that credit tightening over the last 12 months has begun to take a toll on growth, particularly in interest-rate sensitive areas such as housing and consumer spending on big-ticket items.

But it will take more than just a few weeks of data to convince the Fed that the recent downturn is not an aberration. In fact, even a sharp dip in second-quarter gross domestic product growth might not be enough.

Officials are mindful that in the past two years the second quarter has been far weaker than any other and well below full-year growth rates. They may want to see third-quarter numbers before they make up their minds.

Inflation is on a faster track this year than last and is already pressing on the upper limits of the Fed’s comfort zone.

Many at the Fed would like to see the core consumer price index, excluding volatile food and energy prices, running at 2.0% or lower. But in May, that rate was up 2.4% year-over-year.

A resurgence in the price of oil this spring could make for some worsening inflation numbers for June and July and increase the odds of a rate hike at the August FOMC meeting.

“We are going to see some pretty ugly numbers in June and July on CPI because of oil,” Wyss said. “Gasoline prices went through the roof.”

The Fed is at a crucial juncture in its efforts to engineer a “soft landing,” trying to keep the economy from overheating while not overshooting with an excess of credit tightening that could throw the country into recession.

For the last few quarters, demand in the economy was running well ahead of supply, and it was this imbalance that the Fed feared would fuel higher wages and prices.

With such strong demand and unemployment around 30-year lows, pressures on the country’s labor resources are evident.

The strength of demand in the first quarter was a key reason the Fed decided on a more aggressive move at its last meeting, on May 16, where it raised the key federal funds rate on overnight bank lending by half a percentage point to 6.50%.

But lately, things have been moving in the general direction the Fed wants. Unemployment edged up in May and there are signs that robust consumer spending is starting to wane.

The stock market has cooled, particularly the red-hot technology sector. But if stocks reignite on signs the Fed is nearly finished, that could actually keep up the pressure for further hikes.

“Clearly the Fed’s tightening of monetary policy over the course of the past year has begun to have some effect,” said Scott Pardee, a professor of monetary economics at Middlebury College in Vermont and a former Fed economist. “So the question now for the Fed is, have they done enough?”