Federal Reserve in the Spotlight on Eve of Rate Decision

All economy watchers have turned their gaze to the Federal Reserve Open Market Committee today and tomorrow as the central bank weighs how much to boost interest rates in an effort to stem inflation without squelching the economic recovery.

Most economists expect the Fed to hike the overnight lending rate by a quarter point when it issues its decision tomorrow, ending a year-long run where the rate sat at 1 percent, the lowest level since 1958. Those banking on a smaller increase cite the Fed’s May policy statement, the last official word from the committee, that any future increases would be “measured.”

But some say a full half-point increase is not out of the question and point to a series of speeches by Chairman Alan Greenspan and other Fed members who sounded the alarm on inflation earlier this month and warned that, if needed, the central bank would act more boldly than in the past.

Still others say far more important than the rate hike itself will be the forward-looking guidance the Fed issues, which will give insight into whether rates will be going up more quickly in the future. The Fed meets again in August.

Striking a Balance

The Fed will likely lean on past experience as it tries to find the interest rates most likely to allow the economy to continue expanding without causing sharp price increases.

Rather than risk snuffing out a recovery, the Fed will likely lean toward letting the economy grow in the short term, especially because some recent reports, including the Commerce Department’s revised growth data for the first quarter, raised some question about the underlying strength of the recovery and say that core inflation for consumers and manufacturers have risen only slightly.

“There were hints in the first quarter growth revisions that corporations weren’t moving to invest as strongly as had been hoped,” Mark Zandi, chief economist at Economy.com, told the E-Commerce Times. Although consumers have kept the expansion moving at a brisk pace, a lack of conviction in the recovery could give the Fed something to think about, he added.

Zandi and other economists now expect the target rate will be at 2 percent by the end of this year, making it likely that mortgage rates and consumer credit loan rates will go higher and possibly slow the pace at which corporations borrow to invest in capital projects, such as factory expansion or major IT upgrades.

U.S. stock markets, which have been in wait-and-see mode for weeks, were trading higher across the board as the meeting began. By midday Tuesday, the Dow was up more than 60 points while the Nasdaq was up 13.

Impacts Weighed

Many believe the impending interest rate hike and at least one other increase later in the summer are already priced into the stock markets. There is more debate about what impact the hikes will have on sectors of the economy, such as housing, which has fed off the low interest-rate environment.

Nicholas Buss, vice president of market research at PNC Finance, said the housing market will cool, but not stall completely.

“Increased employment and rising consumer confidence should offset most of the impact of higher rates,” Buss told the E-Commerce Times. “It might take the sizzle off this summer, but the sector will continue to perform well.”