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Rate hike on tap at US Fed's final 2005 meet
Updated: 2004-12-14 17:00

US Federal Reserve officials are set to jack up interest rates on Tuesday for a fifth time this year, confident the U.S. expansion is self-supporting and no longer in need of rock-bottom borrowing costs for a boost.

Fed officials are set to gather at 9 a.m. EST and are expected to announce their decision on interest rates around 2:15 p.m.

Economists are united in the view that the U.S. central bank will nudge benchmark overnight rates higher by a quarter of a percentage point to 2.25 percent, part of an effort to lift them to more normal levels after reducing them to 40-year lows.

"It's not a robust expansion, but on the other hand it is an expansion and we are growing fast enough to see improvements in the job market," said David Berson, chief economist at mortgage finance giant Fannie Mae.

The U.S. economy grew at a respectable 3.7 percent annual rate in the third quarter and job growth has averaged 178,000 over the last three months -- not spectacular but fast enough, analysts say, to whittle away at the 5.4 percent unemployment rate posted in November.

Economists say that as the jobless rate moves lower, the Fed will become more watchful on the inflation front.

But for now, most analysts think officials will be content to stick with what they have described as a "measured" campaign to move interest rates up. Since embarking on that campaign in June, the Fed has moved in quarter-point steps at each of its last four rate meetings.

And economists say a rate hike at the Fed's final gathering of the year on Tuesday won't be the last.

Futures markets are betting heavily that policymakers will bump the benchmark federal funds rate up another notch when they next meet in early February. But views are split on whether the Fed will pause to assess the impact of its actions at its subsequent meeting in March.

The median forecast in a survey from the Bond Market Association released on Monday was for a fed funds rate of 2.5 percent by March, 3.0 percent by mid-year and 3.5 percent by the end of 2005.

"They still have a ways to go," said Ken Kim, an economist at Stone & McCarthy Research Associates who also thinks overnight rates will top 3.5 percent by 2005's finish.

"We're seeing evidence that inflation is moving higher. It's not a risk, it's actually happening," he said.

Kim thinks the Fed will acknowledge as much in announcing its rate action on Tuesday.

However, he is in the minority. The broad consensus of Fed watchers is that the central bank will retain its view that upside and downside risks to price stability are balanced.

"I think the Fed feels it has a fair amount of flexibility," Berson said. "While inflation has moved up, it hasn't moved up a lot."

"If economic growth should subside to a below-trend pace, the Fed would feel it has the flexibility to pause in its tightening," he said. "But if growth picked up and caused core inflation to rise a little more quickly, I think the Fed would be prepared to tighten more quickly as well."

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