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US Federal Reserve seen boosting rates despite worries
Updated: 2004-09-21 13:47

Federal Reserve policy-makers were expected to raise US interest rates on Tuesday for a third time this year, continuing to lift borrowing costs from rock-bottom levels despite some signs of economic softness.

A recent Reuters survey of 22 top Wall Street economists found opinion unanimous that the U.S. central bank will nudge the federal funds rate on overnight loans between banks up a quarter percentage point to 1.75 percent from 1.5 percent.

This will be the last Fed policy session before the Nov. 2 presidential vote but that was not seen as a deterrent, given Fed Chairman Alan Greenspan's conviction the economy was on a fairly sound footing.

"After Tuesday's all-but-certain rate hike, it will no longer be possible to assert that 'the Fed never tightens just before an election'," said economist Lou Crandall of R.H. Wrightson and Associates in New York.

The rate-setting Federal Open Market Committee (FOMC) sits down at 9 a.m. EDT and will reveal its decision at around 2:15 p.m. EDT.

The lack of suspense over the Fed's rate action only heightens interest in the words the central bank will use to justify it, with financial market participants trying to gauge how much higher rates are likely to go.

Mind the soft spot

"If the Fed goes any further in saying that the soft patch is over, then we're likely to see more rises," said Rajeev Dhawan, director of Georgia State University's economic forecasting service. "But if they give any indication that the soft patch may not be over, then this could be one of the last moves this year."

At its last policy session on Aug. 10, the FOMC said the economy "appears poised to resume a stronger pace of expansion going forward" and that "policy accommodation can be removed at a pace that is likely to be measured" -- Fed-speak for saying it saw rates as abnormally low.

Subsequently, Greenspan added a qualified assessment that the economy was gathering some steam.

"The most recent data suggest that, on the whole, the expansion has regained some traction," the Fed chief told Congress on Sept. 8.

Exactly when rates will strike a level defined as normal or neutral -- one that neither hinders expansion nor spurs it fast enough to trigger inflation pressures -- is open to debate.

Dhawan says it could be in a range around 2.75 percent to 3 percent, implying several more rate rises ahead, though he said that level was unlikely to be reached until late next year.

Merrill Lynch has taken a harder line, predicting the Fed's current rate-rising cycle, only initiated on June 30 with the first rate hike in four years, already is near completion.

"We think the Fed will actually stop at 2 percent and that that level will be reached at the November 10 meeting," economist Kathleen Bostjancic said. "After the November meeting, we think the Fed will be on hold throughout 2005."

She cites soft job growth and anemic back-to-school shopping reflected in a 0.3 percent decline in August retail sales as key factors, after a lengthy period in which consumer spending has been the driving U.S. economic force.

"The consumer is really starting to show some fatigue here," Bostjancic said. "Our big-picture analysis is that we think the economic soft patch is turning out to be more than just a patch and that the economy is more vulnerable than the Fed had perceived."

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