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Fed expected to leave rates unchanged

©

Latest update : 2008-08-05

The US central bank will confront a dilemma over interest rates at its meeting today. A cut in the main rate could trigger more inflation, whereas a hike could slow down economic growth. The Fed is thus widely expected to leave rates unchanged.

Amid heightened economic uncertainty, the Federal Reserve is widely expected to keep its main interest rate unchanged Tuesday at 2.0 percent.

Economists said that the Federal Open Market Committee (FOMC) will likely stand firm, despite a report Monday showing a cooldown in consumer spending and a spike in inflation pressures.

Analysts say the Fed is caught between a rock and a hard place because a cut in the federal funds rate could trigger increased inflationary pressures while a rate hike could strangle fragile economic momentum.

Thus, Fed chairman Ben Bernanke and his fellow central bankers are expected to sit on their hands during Tuesday's policy meeting.

"I think the Fed is going to stand on the sidelines holding at 2.0 percent. We're getting a very mixed economic picture right now," said Scott Anderson, an economist at Wells Fargo.

Anderson said the world's biggest economy is throwing off conflicting signals which makes it likely that the Fed will not want to tinker with rates this time.

The US economy grew at a 1.9-percent pace in the second quarter which marked an improvement from the first three months of the year, but growth got a timely boost from a giant 168-billion-dollar emergency stimulus.

And although the unemployment rate ticked up to 5.7 percent during July, marking a four-year high, economists say job losses this year are not as bad as in prior recessions.

Some analysts believe the 14-trillion-dollar US economy has already slumped into a recession -- the government revised its tally for 2007 fourth-quarter growth last week to a negative 0.2 percent -- but others say the economic picture is not so dire and that a recession will be avoided.

If market predictions come true, the Fed will keep rates unchanged for a second straight time Tuesday after slashing rates aggressively by 3.25 percentage points between September and late April.

The Fed cut rates in a bid to fire up economic vitality which has been threatened by a lingering housing market downturn, a credit squeeze in the banking industry and searing oil prices.

"I think the housing market is really the central element of this crisis," Bernanke told Congress last month, signaling that a potential rebound in the housing market could trigger an economic revival.

The central bank is unlikely to raise rates until the housing market stabilizes, especially as stretched consumers are cutting back on big-ticket purchases like cars and household appliances.

Some analysts say the Fed would like to raise rates, in part to ward off the inflationary risks presented by high oil prices, but they say the ailing housing market has boxed policymakers into a corner.

The report released Monday, showing headline inflation jumped 0.8 percent in June to post its strongest monthly gain since 1997, could heighten the Fed's inflation debate.

"Yes, consumer price increases are so high that the inflation hawks will be screeching like crazy at tomorrow’s FOMC meeting. Expect some strong language about inflation in the statement but no action," said Joel Naroff, a chief economist at Naroff Economic Advisors.

Economists at Lehman Brothers agreed that the Fed will maintain a wait-and-see approach, in part because of the turmoil roiling US financial markets.

The panel is expected to lift rates later this year after November's presidential election, or by early 2009 on the premise that the housing market will recover, inflationary pressures will cool and wider growth will start to improve.

This outlook has been fed by a decline in world oil prices of late, which were trading around 121 dollars a barrel late Monday, down from record highs of over 147 dollars several weeks ago.

Meanwhile former US Federal Reserve chairman Alan Greenspan warned Tuesday that governments may have to bail out more banks before the global financial crisis is over.

Writing in Britain's Financial Times newspaper, Greenspan also warned of the "awesome cost" of a move towards protectionism by governments, arguing that globalisation was "at the root" of economic growth around the world over the past decade.

"Fears of insolvency have not, as yet, been fully set aside," the former Fed chairman wrote.

"There may be numbers of banks and other financial institutions that, at the edge of defaulting, will end up being bailed out by governments."

Date created : 2008-08-05

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