Fed Likely to Raise Rates a Quarter-Point

Disappointing job growth in July may prompt Federal Reserve (search) policy-makers to ease off on their plans for regular interest rate increases over the coming months.

Analysts still expected the Fed to move rates up by a quarter-point Tuesday, but some economists believed the Fed would then take a breather until after the Nov. 2 election given the employment report that showed job creation came to a near-standstill last month.

"I think the Fed will conclude that this is likely to be a temporary soft patch of the kind that we have gone through many times before," said economist Lyle Gramley, a former Fed board member.

But the Fed could ease off its credit-tightening plan if the economic data continues to show weakness, Gramley and other analysts said.

"I don't think a rate increase is at all certain for the September meeting," said Sung Won Sohn, chief economist at Wells Fargo in Minneapolis. "It will depend on how the numbers come in, with the next employment report being the most important factor."

The Fed will want to see if the job market bounces back after two disappointing months, including a tiny 32,000 jobs created in July. That's the weakest showing since last December and far below the 200,000-plus new jobs economists had expected last month.

The July jobs report was the most dramatic sign yet that the economy had hit what Federal Reserve Chairman Alan Greenspan (search) had earlier termed a "soft patch."

The Fed nudged up its federal funds rate — the interest banks charge each other — from a 46-year low of 1 percent to 1.25 percent on June 30. That was the first increase in four years, and the Fed announced then that it believed future hikes could be made at a measured pace.

When the Fed acted, the economy appeared to be racing ahead. But since then a variety of reports have shown the big spike in oil prices this year caused consumers to cut back dramatically on spending and raised questions among businesses about their hiring plans.

"Without a doubt, this is taking a toll on the economy," said Richard DeKaser, chief economist at National City Bank in Ohio, who estimated that higher energy costs had reduced Americans' disposable income, after taking out inflation, by $35 billion in the first half of the year.

Wall Street took a beating Friday after the disappointing employment report. The Dow Jones industrial average (search) and other major stock barometers fell to their lowest levels of the year because of investor concerns that the economy's slowdown could turn into something worse. Wall Street was mixed Monday as oil prices rose further into record levels.

Many analysts said the main reason they believe the Fed will raise rates by a quarter-point this week is that it failed to make the widely expected increase, investors would worry the economy is in even worse shape than they believed.

"A lack of an increase might suggest that Fed policy-makers are quite concerned about the economy's progress," said Lynn Reasor, chief economist at Banc of America Capital Management in St. Louis.

The Fed's next rate meeting, on Sept. 21, will be the last one before the November elections.

The concern among analysts is that the economy will not strengthen in coming weeks as consumers and businesses continue to struggle with soaring energy prices. Some analysts believe the Fed may end up seeing the spurt in energy costs as a factor holding down overall inflation because of its impact in dampening economic growth.

But Greenspan also cautioned in his midyear report to Congress that should inflation threaten to become a bigger problem than currently expected, the Fed would not hesitate to abandon its "measured" pace and begin moving interest rates up more aggressively.