THE FED

Effects of Raising Interest Rates by The Fed

Effects of Raising Interest Rates by The Fed

Federal Reserve Chairman Alan Greenspan and his colleagues are being buffeted by strong economic crosscurrents — rising inflation pressures on one hand and a sudden slowing in economic growth on the other. Faced with conflicting forces, the Fed is still expected to stay the course, raising interest rates by a moderate quarter-point on Tuesday, the eighth such increase since the central bank embarked on the current credit-tightening campaign last June. “There is certainly not going to be any surprise in their action. Every indication is that the Fed will hike the federal funds target by another quarter-point,” said David Jones, head of DMJ Advisors.

Such a move would push the target for the funds rate, the interest that banks charge each other on overnight loans, from the current 2.75 percent to 3 percent. When the Fed started boosting rates 10 months ago, the funds rate stood at 1 percent, the lowest level in 46 years. The increase in the funds rate is expected to trigger a corresponding quarter-point increase in banks' prime lending rate, the benchmark for millions of business and consumer loans. The prime rate now stands at 5.75 percent. Analysts believe that given the current economic uncertainty, the Fed will not only stick to another quarter-point rate increase but will also make few changes in the wording of the statement announcing the action.

The expectation is that the Fed, as it has been doing for a year, will pledge to make any further rate increases at a “measured” pace, which has come to mean further quarter-point moves. The steady-as-she-goes prediction is a far cry from the expectations about the Fed's next moves that were being made immediately after its last meeting on March 22. At that time, Wall Street began bracing for the Fed to ditch the promise to be measured and jack up rates by a half-point. That fear of more aggressive Fed credit-tightening was fanned by a change of wording in the March Fed statement to acknowledge more worries about inflation. Since then, however, various indicators showed the economy slowing sharply in March. The government reported last week that this sudden slowdown had dragged down economic growth to a rate of just 3.1 percent in the first three months of the year, the slowest pace in two years.

That slowdown has eased fears for the time being about the Fed becoming more aggressive in its rate hikes. Analysts, however, are not looking for a pause in the gradual quarter-point increases because various inflation statistics are continuing to flash some warning signals. Consumer prices jumped 0.6 percent, reflecting the surge in energy costs, but even outside of volatile food and energy, the so-called core rate of inflation was up 0.4 percent in March, the biggest jump in 2½ years. Imagine you're driving a car with a blacked-out windshield and a loose steering wheel. Now imagine that your car is the $13 trillion ...