Fed Poised to Raise Rate by Quarter-Point

Fighting inflation is job No. 1 these days for the Federal Reserve (search). With energy and other prices rising, policy-makers are expected to keep nudging up short-term interest rates — for now.

At its meeting Tuesday, the Fed is poised to raise the federal funds rate by one-quarter of percentage point, to 3 percent. That would be the eighth such increase since June 2004, when the central bank began its campaign to tighten credit.

Inflation is creeping higher, but the economy has shown signs recently of hitting a rough patch. So Fed Chairman Alan Greenspan (search) and his colleagues have to tread lightly.

"They now have to walk a very tight line between growth and inflation," said Lynn Reaser, chief economist at Bank of America Capital Management.

To control inflation, the Fed must stick to rate increases while balancing that goal with trying to keep the economy on a solid growth path, Reaser said.

Higher rates are a defense against an outbreak of inflation. But when it is more expensive to borrow money, some consumers and businesses are less inclined to spend and invest.

Over the first three months of the year, the economy grew at a 3.1 percent annual rate, the worst performance in two years. Analysts blame much of the blame on soaring energy prices, which restrained spending by individuals and companies.

Some economists believe economic growth in the April-to-June period could prove even worse.

The current climate probably will not do much to energize the labor market, analysts said. Employers added just 110,00 jobs in March, the fewest in eight months. April's employment report comes out Friday; economists predict it will show that 170,000 jobs were created.

Inflation, meanwhile, is climbing. Driven by expensive gasoline and energy products, overall consumer prices jumped by 0.6 percent in March, the biggest increase since October.

Even more troubling to economists was the 0.4 percent rise in core inflation — a gauge that excludes energy and food prices. That was the largest increase in 2 1/2 years.

At the Fed's previous meeting, on March 22, policy-makers struck a hawkish tone about inflation, saying companies were finding it easier to raise prices.

Reaser is among the economists who believe the Fed probably will increase interest rates through much of this year. Other analysts think the Fed might pause in the summer, especially if growth slows even more than anticipated.

If the Fed goes ahead Tuesday with a quarter of a percentage point increase in the interest that banks charge each other on overnight loans, then the prime lending rate at commercial banks would rise by a corresponding amount, to 6 percent. The prime rate is used for many short-term consumer and business loans.

Throughout the Fed's rate-raising campaign, the central bank has said it can boost rates gradually. In the Fed's language, that comes across as "at a pace that is likely to be measured."

To analysts, that phrase translates into quarter-point increases.

"A measured pace of rate increases is our best guess, for now," on what to do, Fed member Donald Kohn said in a recent speech. "All should understand that the guidance we do provide cannot and will not deflect us from changing our strategy whenever we believe doing so to be necessary."

At the Fed's March meeting, policy-makers considered abandoning that gradual approach. That debate is expected to resume Tuesday.

Ditching the "measured" language might signal more aggressive rate action in the future, which could rattle Wall Street, or perhaps an impending pause in rate increase.

If the language is retained, it might sway people to take on riskier investments than they otherwise would, analysts said.

Mark Zandi, chief economist at Economy.com, believes the "measured" language is one reason why longer-term interest rates, such as those on mortgages, are still relatively low.