Posted on: Wednesday, November 10, 2004

Rate increases by Fed expected into 2005

By Martin Crutsinger
Associated Press

WASHINGTON — The Federal Reserve is expected to nudge interest rates up for a fourth time this year today, acting on the belief that the economy has finally emerged from an extended "soft patch."

And the November rate increase is likely to be followed by another quarter-point move at the Fed's final meeting of the year on Dec. 14, with more rate hikes to come in 2005, analysts say.

That represents a change in thinking from just a week ago, when many were predicting that the Fed would raise rates this month but then would pause to assess the effect on the economy of its credit-tightening campaign.

What changed the forecast was the far better-than-expected employment report for October that showed the nation's businesses adding 337,000 workers last month, the biggest one-month gain in seven months and more than double what had been forecast.

The big surge in hiring was taken as the strongest signal yet that the economy is starting to regain steam after slowing dramatically during the summer largely because of surging energy prices.

"We are certainly out of the soft patch, and I think the economy is getting on firmer ground," said Sung Won Sohn, chief economist at Wells Fargo in Minneapolis.

The Fed started raising interest rates in June with the federal funds rate, the interest that banks charge on overnight loans, at a 46-year low of 1 percent. The three quarter-point rate hikes in June, August and September have pushed the funds rate to 1.75 percent.

Banks' prime lending rate, the benchmark for millions of consumer and business loans, has risen from 4 percent in June, the lowest level since 1958, to 4.75 percent currently.

A rate hike today would put the prime rate at 5 percent, still well below the 9.5 percent level for the prime rate in early 2001 shortly before the Fed began an aggressive easing campaign to deal with the shocks of a bursting stock market bubble and the 2001 recession.

The federal funds rate stood at 6.5 percent before the Fed's first rate cut in January of 2001, but analysts doubt that the Fed is aiming for rates that high in its current credit tightening campaign.

Rather, the central bank is trying simply to get back to a neutral level for the funds rate, a level where the economy can grow at a pace that does not trigger excessive inflation. Although the Fed has not said where the neutral level is for the funds rate, many economists believe it is around 4 percent.

That would take nine more quarter-point moves to get from 1.75 percent to 4 percent on the funds rate. After the final two meetings this year, that would translate into seven more quarter-point moves next year.

Many analysts believe that timetable, virtually to the end of 2005, is exactly what Federal Reserve Chairman Alan Greenspan has in mind, given that his long tenure at the Fed ends in early 2006.

"I think they are going to keep raising rates for an extended period of time," said David Wyss, chief economist at Standard & Poor's in New York. "I think Chairman Greenspan would really like to get back to neutral before he leaves."