Fed Bankers to Discuss Interest Rates Tuesday

Conflicting economic risks that could emerge from Hurricane Katrina will put Federal Reserve policymakers in a challenging spot when they meet Tuesday to decide on their next move with interest rates.

Fallout from Katrina is expected to slow economic growth over the rest of the year, which some experts say argues for the Fed to temporarily halt its credit-tightening campaign.

But a main argument for the central bank to stay the course is the fear that high energy costs, made worse by the killer storm, could filter down and affect the price of all kinds of things. Broader inflation could follow.

A jump last week in the price of gold -- a classic inflation hedge -- to 17-year highs has raised eyebrows, and inflation jitters, on Wall Street.

Until Katrina hit the Gulf Coast, analysts were virtually unanimous in expecting Fed Chairman Alan Greenspan and colleagues to lift their key short-term interest rate, now 3.5%, to 3.75% at Tuesday’s meeting. It would be the 11th such increase since June 2004, and would put short-term rates at four-year highs.

With the surge in oil, gasoline and natural gas prices after Katrina, however, many economists believe consumer spending could weaken significantly in the fourth quarter, damping the economy.

“I think the greater risk is that higher energy prices will cause consumers to pull back, slowing overall economic growth,” said Kathleen Camilli, president of Camilli Economics. She is on the side of those who think the Fed will leave rates unchanged Tuesday.

Perceived political pressure also could weigh on the Fed, some say.

“I think this is very, very tough for the Fed. There’s also the compassion issue. You run the risk of looking very callous by raising rates,” said Brandeis University economics professor Stephen Cecchetti.

Even so, most analysts believe the Fed will tighten again on Tuesday. In a Reuters survey Thursday of Wall Street’s primary Treasury bond dealers, 16 of 21 expected a rate hike.

Lynn Reaser, chief economist for Bank of America’s Boston-based investment strategies group, said she believed that the Fed would focus on the longer term, not on temporary disruptions to the economy from the hurricane, and would go ahead with another rate increase.

“Really the best support they can give in this situation is to keep the economy on a sound footing with low inflation,” she said. “Right now we’re already starting to see that rebuilding is underway and energy prices are moving lower, so that makes it easier for them to stick to their strategy.”

Indeed, crude oil prices ended Friday at $63 a barrel, a six-week low, amid signs that high prices have begun to curb consumption.

The Fed also might be persuaded to continue tightening credit because of inflation warning flags in financial markets.

Gold futures prices in New York rose $10.50 an ounce last week and were at 17-year highs Friday, with the near-term futures contract at $459.50 an ounce.

Gold is “a flight-to-safety vehicle and an inflation hedge,” said William O’Neill, a partner at Logic Advisors in Upper Saddle River, N.J.

The Treasury bond market last week also showed signs of nervousness over the prospect of a ballooning federal budget deficit because of post-Katrina spending. The 10-year Treasury note yield was at 4.27% on Friday, a five-week high and up from 4.12% a week earlier.

If the Fed were to appear soft on inflation, it could make investors less willing to hold long-term bonds because rising inflation eats away at fixed-rate returns, analysts say.

As for the stock market, it has been relatively unflustered by Katrina. In fact, most market indexes have risen since the storm hit on Aug. 29. Anticipation of economic benefits from rebuilding have bolstered some sectors, including engineering firms and building-material companies.

The Dow Jones industrial average ended at 10,641.94 on Friday, down 0.3% for the week after rising a total of 2.7% in the previous two weeks.

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Associated Press, Reuters and Bloomberg News were used in compiling this report.