Fed Expected to Raise Rates 1/4 Point in Greenspan's Finale

WASHINGTON – Fed Chairman Alan Greenspan will end his 18-year rule on Tuesday with a rate hike of a quarter percentage point and the message that borrowing costs may go up again in March if warranted by growth and inflation.

Disappointing fourth quarter U.S. gross domestic product numbers on Friday should not shake Federal Reserve confidence the economy is on a reasonably solid footing, analysts said.

But higher core inflation shown in the data ought to ensure that it retains a slight tightening bias, which markets bet means one more rise before ending the current rate-hike cycle.

"The statement will continue the thrust that confidence on their part is quite strong on economic fundamentals and they place a higher risk on inflation," said Lynn Reaser, chief economist of Bank of America Capital Management.

Analysts also expect some adjustment to the Federal Open Market Committee's statement to indicate future actions will be shaped by how the economy unfolds, which would also provide some flexibility for incoming Fed Chairman Ben Bernanke.

"They must leave the slate clean for Bernanke. Giving the impression that they are done (at 4.5 percent) would ... extend Greenspan's tenure beyond January 31," said Anthony Chan, chief economist at JPMorgan Private Client Services.

A key phrase in the last FOMC statement was "some further measured policy firming is likely to be needed" and 16 of 18 analysts polled by Reuters on Thursday expected this to be modified, perhaps changing "is likely to" to "may" be needed.

"This would signal that they were near to the end of the cycle," said former Fed Governor Lyle Gramley, who put the chances of another hike in March at 50/50.

The FOMC begins meeting at 9.00 a.m. EST and will release its statement after 2.15 p.m. EST.

All analysts polled by Reuters expect the U.S. central bank to lift its target rate to 4.5 percent on Tuesday from 4.25 percent and 17 out of 21 thought it would go again at the following meeting, on March 28, Bernanke's first as chairman.

The statement will probably also be adapted to take account of somewhat softer economic conditions since its last meeting, on December 13, although this will likely be balanced by expectations for a stronger start to the new year.

Preliminary fourth quarter GDP data showed the economy slowing unexpectedly to just a 1.1 percent annualized pace, from 4.1 percent in the previous three months and below the 2.8 percent forecast by Wall Street.

But analysts said this masked healthy underlying growth and pointed to a rebound in 2006, which was a view also endorsed by recent upbeat numbers on jobs and businesses investment.

They also thought the Fed would pay more attention to inflation after the core PCE price index — the Fed's favored measure which gauges the prices faced by consumers — rose to 2.2 percent at an annualized pace from 1.4 percent.

This is above the preferred range of 1.0 to 2.0 percent indicated by a number of FOMC members, including Bernanke when he was a Board governor.

"Economic fundamentals do not make a compelling case for the Fed to stop at 4.5 percent," Lehman Brothers told clients in a note. "Core PCE inflation accelerated in the fourth quarter and on a quarterly basis is again running above the 'Bernanke boundaries'."