Fed Poised to Raise Interest Rates

Now that the economic recovery is on solid ground and the jobs climate is improving, Federal Reserve (search) policy-makers are ready to boost interest rates for the first time in four years.

Ultra-low rates are no longer needed to support the economy and inflation is coming out of hibernation, reasons enough for the Fed to embark on a credit-tightening campaign that is expected to stretch well into 2005.

Fed Chairman Alan Greenspan (search) and his colleagues have sent numerous signals to Wall Street and Main Street, especially since their last meeting on May 4, that short-term rates are going up. In anticipation of that, some long-term rates, such as those on mortgages, already have moved higher.

For a year, the Fed's primary tool to influence economic activity — the federal funds rate (search) — has been at 1 percent, a 46-year low. Economists widely expect that Fed policy-makers, at the end of a two-day meeting on Wednesday afternoon, will decide to boost the funds rate by one-quarter percentage point.

"This will be the first step in a long journey to bring interest rates to higher ground," said Stuart Hoffman, chief economist at PNC Financial Services Group.

Any increase to the funds rate — the rate banks charge each other on overnight loans — would likely be followed by a similar boost to commercial banks' prime lending rate, the benchmark for many short-term consumer and business loans. The prime rate has been at 4 percent, the lowest level in more than four decades, for a year.

The economy has been a hot topic in the presidential campaign with President Bush insisting things are rebounding and John Kerry talking about a squeeze on the middle class. Analysts said voters will likely see little impact on the economy between now and November from the Fed's expected quarter-point hikes.

A one-quarter point increase would not deter the economic recovery, but it will put the Fed on a course of higher borrowing costs, geared in part to head off inflation, economists said.

For the first five months of this year, consumer prices rose at an annual rate of 5.1 percent, exceeding the 1.9 percent increase for all of last year. Excluding volatile energy and foods costs, "core" prices increased at a rate of 2.9 percent, compared with a 1.1 percent advance registered for 2003.

Although the current rate of inflation is still low by historical standards, businesses are finding it easier to raise prices now than during the economic slump.

Greenspan, in remarks earlier this month, noted that there's been a swing from "heavy business price discounting to the restoration of a significant degree of pricing power."

At their last meeting in May, Greenspan and his colleagues expressed the view that they could gradually raise rates to keep the economy and inflation on an even keel.

But some economists wondered whether the Fed on Wednesday might drop or change language contained in its last statement that any rate increases could be "at a pace that is likely to be measured." Such a move, analysts said, would be aimed at getting across the message that the Fed is prepared to take more aggressive action if inflation forecasts turn out to be worse than expected. Greenspan has made this point in public speeches and remarks several times since the Fed's last meeting.

Some economists predict the funds rate could rise to 2 percent by the end of this year, which would mean the prime rate would move up by a corresponding amount to 5 percent.

Overall, economists are expecting Fed policy-makers to strike an upbeat tone about the economy in the statement released after Wednesday's meeting.

The economy, which was knocked down by the 2001 recession and jolted by the Sept. 11, terror attacks and corporate accounting scandals, finally staged a material rebound in the second half of last year.

The economy grew at a decent 3.9 percent annual rate in the first quarter of this year. But projections for the current quarter are wide-ranging, from a 2.5 percent rate to just over a 4.5 percent pace. Economist say estimates would be stronger if not for the expectations that higher energy costs will probably dampen consumer spending, a key force in the economy.

Companies, meanwhile, have stepped up hiring in the last several months -- signaling a long-awaited turnaround in the labor market. The economy added 248,000 jobs in May, compared with a loss of 28,000 for the same month last year.