Fed to raise U.S. rates Tuesday, more to follow
By Knut Engelmann
WASHINGTON, March 20 (Reuters) - The U.S. economy is firing on all cylinders, giving the Federal Reserve no choice but to bump up interest rates at a key meeting Tuesday -- the latest, but certainly not the last, of a series of small rate rises.
The result of the routine meeting of the Fed's rate-setting Federal Open Market Committee is a foregone conclusion among Fed watchers. What they can't quite agree on is how long the Fed will remain in tightening mode.
The answer to that question, they say, will be the extent to which the economy continues to ignore the Fed's actions.
Despite four rate rises since last June, neither consumers nor stock market investors have paid much heed to Fed Chairman Alan Greenspan's slow-motion monetary policy designed to keep rising inflation from undermining the record U.S. expansion.
As key U.S. stock prices continue their high-flying wire act, pumping money into consumers' already bulging wallets, Fed officials remain worried that demand outstrips supply in the tightly stretched economy, putting pressure on prices.
``As long as growth in the economy remains robust and momentum continues to be strong, we think that the Fed will raise rates,' Warburg Dillon Read said in a research note.
Other Wall Street firms agree, and all 30 of the nation's primary dealers -- those that deal directly with the Fed -- forecast the fed funds overnight bank lending rate will be upped by a quarter-percentage point to 6.0 percent on Tuesday.
Almost a third of those firms sees the fed funds rate at 6.75 percent by the end of the year -- implying at least two more Fed tightenings, possibly three if Greenspan sticks by his declared intention to pursue a strategy of incremental steps. Another third is betting on a 6.50 percent rate by year-end.
Analysts say nothing short of a drastic correction in the stock market, which Greenspan now regards as one of the key factors fueling the red-hot growth of consumer demand, will convince the Fed from holding off from further rate rises.
``Without a sustained correction in the stock market, a meaningful economic slowdown is not likely,' said Sung Won Sohn, chief economist at Wells Fargo Bank in Minneapolis. ``That means a 20 percent decline in the S&P 500 index over six months is what they are looking for at the Fed.'
Such a drop would bring the broad-based U.S. stock market gauge back to about the level it was at the start of 1999.
In past testimonies and speeches, Greenspan has made it abundantly clear that he is not targeting a particular level of stock prices, arguing time and again that it is not his job to second-guess the judgment of millions of investors who are betting the good economy will lift future corporate earnings.
REALITY CHECK
But that does not mean he will stop asking investors to doublecheck their expectations against reality. Higher credit costs eventually will hurt companies trying to raise cash for new equipment just as they will hurt consumers seeking credit for a new house or car. Eventually, the Fed hopes, its actions will help to slow demand and thus, the economy's growth rate.
For now, the Fed's gradual maneuverings come against a background of still-muted inflation, at least outside the energy sector. Consumer prices rose by 0.5 percent last month, and without the more volatile food and energy parts, the index was up a mere 0.2 percent.
But with oil prices hovering at precarious heights, and labor markets tighter than ever before in the past generation, Greenspan and his colleagues are clearly worried that the risk of spiraling wages and prices is a very real one.
``The Fed will tighten until it thinks labor market pressures no longer pose inflation risks,' said Tom Gallagher of political analysis firm ISI Group.
The FOMC's rate decision will be released at around 2:15 p.m. (1915 GMT) on Tuesday. Should Fed policymakers decide that another rate hike will be necessary, they will likely do so at their next scheduled meeting on May 16.
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