What the Fed Will Be Looking at Tuesday

NEW YORK – The Federal Reserve (search) will likely push ahead with an increase in borrowing costs when it meets to set interest rates on Tuesday, despite signs of weakness in the economy, most analysts believe.

All 20 economists surveyed by Reuters on Friday after a disappointing July employment report predicted a quarter-point rise in the official federal funds rate (search) to 1.50 percent from 1.25 percent, although the decision to raise rates will be more difficult than it first seemed.

It would be the second tightening in a cycle that only got started in June, before a wave of data that dampened the outlook for growth. Last month, Fed officials said the soft patch should pass.

If it doesn't, economists say the Fed's planned tightening path for the rest of the year could be in doubt.

Still, there were a few analysts on Monday willing to bet the Fed will hold off raising rates this week and wait until doubts about the economic "soft patch" have lifted.

Fed policymakers are due to release a statement at the end of their meeting around 2:15 p.m. on Tuesday, announcing any change in policy.

The following are a few of the main factors the Federal Open Market Committee (search) will be considering.

* Consumer spending slowed sharply in the June quarter and dragged down overall economic growth to a moderate 3.0 percent. Fed officials played down the weakness for June as temporary.

* Auto sales for July posted a solid rebound to an annual rate of 17.3 million cars from anemic levels around 15 million in June, helped by fresh dealer incentives. The jump helped allay worries about the June soft spot in spending.

* A key factory index from the Institute for Supply Management (search) showed manufacturing activity rose in July from already high levels, while prices paid fell to a six-month low.

* The persistence of high energy prices, currently at a record just below $45 a barrel, casts a shadow over the economic outlook. Policymakers had thought the prior increase in oil and its dampening effect on spending would be transitory, but the latest run-up suggests it will remain a negative.

* Annual core inflation, excluding food and energy, is up around 1.5 percent by the Fed's preferred measure, and there was some moderation in June. But officials will be watching for any fresh upticks.

In his semi-annual testimony to Congress on July 20, Fed Chairman Alan Greenspan (search) said the soft patch in the June data should prove "short-lived."

He also stressed the choice in monetary policy was between measured and a more aggressive pace of tightening. But futures markets have backed away from the aggressive view after the July payrolls report.

* Futures markets are now pricing in just two more rate hikes this year and a 50-50 chance of a third move, in the four remaining policy meetings of 2004. The market had thought the Fed would raise rates at each one, taking the funds rate to 2.25 percent by Christmas.

* The yield on the 10-year Treasury note has dived to 4.26 percent from highs around 4.60 percent last month, giving fresh stimulus to the economy even while the Fed was tightening.

* Stocks have been plagued by doubts about the economy, with the S&P 500 down 6 percent since the Fed last met.