NEW YORK, June 23 (UPI) -- The Federal Reserve's Open Market Committee is widely expected to boost short term interest rates for the first time in more than four years by one-quarter percentage point next week at the conclusion of its policy-making meeting.
The FOMC will hold its two day policy meeting on Tuesday, June 29 and Wednesday, June 30. The Fed's decision on rates is expected at approximately 2:15 p.m. EDT next Wednesday.
The nation's central bank is expected to lift the key federal funds rate, which influences borrowing costs throughout the economy, to 1.25 percent from 1 percent.
The last time the nation's top bank lifted the federal funds rate was back on May 16, 2000, when it hiked the rate 50 basis points to 6.50 percent.
The federal funds rate was cut to the four-decade low of 1 percent from 1.25 percent back on June 25, 2003 and has held at that level at the central bank's last nine meetings.
The nation's top bank cut its target for short-term rates 11 times in 2001, a record for a calendar year, to fight the effects of a recession that likely began in March 2001 and was worsened by the Sept. 11 terror attacks. The central bank cut rates at each of its eight scheduled meetings in 2001 and during three impromptu conference calls. Three of the reductions occurred after the Sept. 11 terrorist attacks in New York and Washington.
The level of interest rates affects the economy. Higher interest rates tend to slow economic activity; lower interest rates stimulate economic activity. Either way, interest rates influence the sales environment.
In the consumer sector, few homes or cars will be purchased when interest rates rise. Furthermore, interest rate costs are a significant factor for many businesses, particularly for companies with high debt loads or who have to finance high inventory levels.
Analysts said Federal Reserve Chairman Alan Greenspan has removed any questions about how the central bank intends to go about raising interest rates to remove some of the monetary stimulus that has solidified the U.S. economic expansion.
In testimony at his confirmation hearing for a fifth four-year term as chairman, Greenspan told the Senate Banking Committee, "Inflationary pressures are not likely to be a serious concern in the period ahead.''
Experts said that remark made it clear that the nation's top bank will only raise its target for overnight interest rates by one-quarter percentage point at the end of its June 29-30 meeting, and that Greenspan's current intention is to proceed from there at a "measured"' pace in increasing rates.
In other words, what officials will actually do at the August, September, November and December meetings of the Federal Open Market Committee will depend on the new economic data.
The preference on the chairman's part is to move relatively slowly, perhaps with further 25 basis-point increases at two or three of those meetings.
Sung Won Sohn, chief economist for California-based Wells Fargo said the Fed should start hiking interest rates as soon as possible to stabilize the economy.
Sohn said, "The U.S. economy is humming now, but the risk of an economic slowdown later this year has risen. In the short run, it is good to have low interest rates, but when you look at longer-term economic stability, too much liquidity in the economy and very low interest rates are not good for the long-term stability of the financial markets."
Sohn noted that the high price of oil and commodities and troubling geopolitical conditions are concerns for the U.S. economy. However, he added, "I believe the economy is strong enough and this is a good time to start hiking interest rates."
Greenspan back on June 8 said the U.S. central bank is ready to raise interest rates and would accelerate the pace of increases if inflation exceeds the Fed's forecast.
The Federal Open Market Committee "is prepared to do what is required to fulfill our obligations to achieve the maintenance of price stability so as to ensure maximum sustainable economic growth,"' Greenspan said.
Greenspan sought to reassure investors that the Fed was not setting them up for a repeat of 1994, when the central bank starting tightening monetary policy with quarter-point increases in the overnight banking lending rate, only to follow with bigger increases to stem inflation. The Fed raised the rate to 5.5 percent at year-end from 3 percent at the start of 1994.
"Unlike 1994, there has been an appreciable increase of market rates in anticipation of policy tightening," Greenspan said.
He added that "history cautions that investors' anticipations of the cumulative magnitude of policy actions and their timing under such circumstances is far from perfect.''
David Wyss, chief economist at Standard & Poor's Corp., said, "The next tightening move after the upcoming meeting is likely to come a bit quicker than expected -- probably before the November election. The Fed funds rate is likely to be 1.75 percent and possibly 2 percent by yearend. We expect a hike of three percentage points in the benchmark rate, to 4 percent, over the next two years.
"All in all, the wild card of surging energy prices puts the Fed in a difficult position as it tries to balance economic growth and price stability. Investors may be thinking Alan Greenspan & Co. can sit back and let the oil-price spike slow the economy on its own, but the Fed may realize that it needs to go ahead and gradually increase superlow rates since the higher energy prices won't have as big an effect on the economy as they did 24 years ago," Wyss said.
The Fed hiked interest rates 2.5 percentage points in 1994 as it tried to get ahead of rising inflation expectations. In early February of 1994, Greenspan, urged FOMC members to raise rates slowly because financial markets were unprepared for larger moves.
The FOMC on May 4 left the overnight rate unchanged at 1 percent, nearly a 46-year low, saying "policy accommodation can be removed at a pace that is likely to be measured.''
Companies have been reporting increased pricing power in recent months, and Greenspan said that the Fed has be prepared to capture some change in inflation dynamics that it may not see yet.
David Kelly, economic advisor at Putnam Investments in Boston, said, "In the last 50 years, the US economy has seen 10 tightening cycles where the Federal Reserve has steadily increased short-term interest rates for a year or more. On average, the Fed has increased short-term interest rates by 2.2 percentage points in the first year of a tightening cycle."
Kelley said, "In every single case, long-term interest rates have risen in the year following the first tightening move, with the yield on the 10-year Treasury bond rising by an average of 1.1 percentage points during that period. In 7 out of 10 cases, year-over-year inflation was higher one year into the tightening cycle, with an average overall change in the inflation rate of 0.6 percent. In 6 out of 10 cases, stocks were higher one year into the tightening cycle, with an average overall change of 8.4 percent.
"We believe the Fed means what it says when it talks about a measured increase in interest rates. On average, the Fed has increased interest rates by 2.2 percentage points in the first year of a tightening cycle. However, this time around, even without Fed tightening, the economy should be slowing down as a result of a squeeze on consumer income and an overheated real estate sector," Kelley said.
Analysts said the history of previous Fed tightening cycles should give investors food for thought. Relative to previous cycles, however, the bond market has never been more prepared, the inflation prospect has rarely been as positive, and the Fed has hardly ever been so committed to taking it easy in raising rates.
The FOMC consists of the seven Governors of the Federal Reserve Board and five Federal Reserve Bank presidents. The FOMC meets eight times a year in order to determine the near-term direction of monetary policy. Changes in monetary policy are now announced immediately after FOMC meetings.
The Fed determines interest rate policy at its meetings. These occur roughly every six weeks and are the single most influential event for the markets. For weeks in advance, market participants speculate about the possibility of an interest rate change at these meetings. If the outcome is different from expectations, the impact on the markets can be dramatic and far-reaching.
The interest rate set by the Fed, the federal funds rate, serves as a benchmark for all other rates. A change in the fed funds rate, the lending rate banks charge each other for the use of overnight funds, translates directly through to all other interest rates from Treasury bonds to mortgage loans.