A growing number of Wall Street's biggest bond trading firms say the Federal Reserve by year-end will lift its target overnight lending rate between banks to at least 2 per cent, the highest level since 2001.

Fed Chairman Alan Greenspan told Congress last week that an economic slowdown in June would be "short lived." His testimony persuaded more economists that the central bank would continue to raise interest rates at what it calls a "measured" pace, or 25 basis points at each of four remaining meetings this year starting August 10. A basis point is 0.01 percentage point.

Economists at 18 of the 22 primary US Government securities dealers that trade with the Fed's New York branch predict the interest-rate target will rise to 2 per cent or more from the current 1.25 per cent, according to a Bloomberg News survey. In mid-June, 14 of the then 23 primary dealers anticipated a federal funds rate of 2 per cent by year-end.

"Once the Fed starts on the path of tightening, it's very hard to knock it off that path," said Ethan Harris, Lehman Brothers Inc's New York-based chief US economist. "The fact that Greenspan said financial markets seem ready to handle higher interest rates suggests that they will continue with 25 basis points per meeting."

Harris forecasts the fed funds rate will be 2.25 per cent at year-end, compared with his June prediction of 2 per cent.

Economists at BNP Paribas, Barclays Capital Inc, Deutsche Bank Securities Inc, Goldman, Sachs & Co, J.P. Morgan Securities Inc, and RBS Greenwich Capital also expect 2.25 per cent or higher, up from four firms in June.

Mizuho Securities USA Inc did not provide a forecast. In the June survey, the firm's year-end estimate was 1.75 per cent.

Greenspan's testimony ended a five-week rally in government debt prices by damping speculation the Fed would refrain from raising its interest-rate target at one of the four meetings.

Higher rates can lead to increased borrowing costs on everything from credit cards to mortgages. Already, the average fixed rate on a 30-year home loan is 5.98 per cent, up from 5.38 per cent in March, according to Freddie Mac. The difference is an extra US$26,900 in interest costs over the life of the loan.

The Fed on June 30 lifted its interest-rate target from 1 per cent, the first increase since 2000. In the weeks after, government reports showing a decline in retail sales, smaller-than-forecast job creation and slower inflation for June caused traders to trim bets on further Fed increases.

Greenspan's comments last Tuesday and Wednesday caused traders to again add to those bets. The yield on the benchmark two-year US Treasury note is 2.74 per cent, up from 2.53 per cent. The yield is more sensitive to changes in monetary policy than that of longer-dated debt.

"The Fed will be more under the gun to get the funds rate back to what they see as neutral," said Edward McKelvey, a senior economist at Goldman Sachs in New York, who in June forecast a year-end fed funds rate of 2 per cent.

Thomas Hoenig, president of the Fed's Kansas City branch, said in a Monday speech to business leaders in Denver that most economists estimate the neutral rate, one that neither stimulates nor restrains economic growth, is between 3 per cent and 4.5 per cent. Hoenig votes on monetary policy this year.

A rise in unit labour costs, a sign of inflation, was the impetus for the change in Goldman Sachs' prediction, McKelvey said. The amount paid for each unit of production rose 0.8 per cent in the first quarter, up from a preliminary reading of 0.5 per cent, according to Labor Department figures released June 3. Costs increased 1.7 per cent in the previous three months.

Barclays' forecast for a 2.5 per cent year-end fed funds rate was the highest. BNP Paribas economists said it will be either 2.25 per cent or 2.5 per cent.

In a survey of the primary dealers taken on April 26-29, eight firms predicted no increase this year, with Barclays among the four that forecast the rate would reach 2 per cent.

Government reports released after that survey showed inflation accelerated and the addition of 671,000 jobs in the second quarter, the most since the first three months of 2000. June's 112,000 new jobs, though, was less than half the median estimate of economists surveyed by Bloomberg News.

A Labour Department report on July 16 showed consumer prices rose 3.3 per cent in June from a year earlier, the biggest 12-month increase since May 2001. For the month, they rose 0.3 per cent, compared with 0.6 per cent in May.

(China Daily 07/30/2004 page12)