WASHINGTON – The Federal Reserve (search), wanting to keep inflation at bay, is expected to boost short-term interest rates for a third time this year on Tuesday, a move that would come in the final stretch of the presidential campaign.
Private economists have mixed opinions on whether the economy is still working through or has already emerged from its late spring blues, but most believe the economy is in good enough shape for the Fed to raise the rates again.
Inflation isn't currently threatening the economy, but the Fed wants to make sure it doesn't become a problem, which is why economists anticipate Fed policy-makers will increase the target for the federal funds rate from 1.50 percent to 1.75 percent. That rate is the interest banks charge each other on overnight loans and is the Fed's primary tool for influencing the economy.
Such an increase would mean that commercial banks' prime lending rate, a benchmark for many short-term consumer and business loans, would climb from 4.50 percent to 4.75 percent.
The expected Fed rate increase would come with Election Day just six weeks away. President Bush and his Democratic rival, John Kerry, hold widely divergent views about how the economy and the nation's job market are faring.
Incumbent politicians normally are unhappy if the Fed raises rates close to an election. Yet, some economists said that by doing so, the Fed could appear comfortable about the pace of the economy's expansion, which might be seen as good for the Bush campaign.
Even with the expected increases, both the funds rate and the prime rate would still be low by historical standards, analysts said. Before the Fed ordered its first rate increase this year in June, the funds rate for a year had been kept at 1 percent, a 46-year low, to help support the economy.
A series of 13 rate reductions that began in January 2001 and ended in June 2003 dropped the funds rate to 1 percent as the Fed fought to help an economy staggered by a series of blows — a plunging stock market, the 2001 recession, terrorist attacks and two wars.
Now that the economy is out of the crisis zone and no longer needs a bracing tonic, analysts said, the funds rate must be moved up from what economists call "emergency" levels of liquidity.
"Fed members are concerned that if they don't raise rates at least modestly now, they'll have an inflation problem down the road," said Mark Zandi, chief economist at Economy. com (search). "The economy is improving enough for the Fed to continue on its path of small rate increases."
Fed policy-makers must always be vigilant when it comes to inflation, said Fed member Edward Gramlich. "The worst possible outcome is for monetary policy-makers to let inflation come loose from its moorings," he said in a recent speech.
Analysts believe the funds rate will rise to 2 percent by the end of 2004. Economists, however, have mixed opinions on how rate increases will unfold after Tuesday's meeting. Some think the Fed will boost rates again at its Nov. 10 meeting and stand pat Dec. 14 — its last meeting of the year. Others believe the Fed might take a pass in November, but raise rates in December.
Sung Won Sohn, chief economist at Wells Fargo, says the Fed's rate-raising campaign has two stages. The first aims to bring the funds rate to 2 percent by the end of this year, Sohn said, "to eliminate the emergency level of liquidity provided after 9/11."
The second stage, he said, is for the funds rate to climb to around 4 percent by the end of 2005. The pace of those rate increases will depend on the economic data at the time.
Fed Chairman Alan Greenspan (search) told Congress earlier this month that the economy had "regained some traction" after hitting a "soft patch" in the late spring, due largely to soaring energy prices.