Another Interest Rate Hike Expected

WASHINGTON – The Federal Reserve (search), responding to solid growth in the economy after a brief slowdown early in the year, is expected to keep raising interest rates.

The Fed's credit tightening campaign will keep mortgage rates (search) and other consumer interest rates rising as well but at a pace that should slow only modestly the nation's booming housing market, private economists believe.

Federal Reserve Chairman Alan Greenspan (search) and his colleagues are meeting Tuesday to discuss what to do with interest rates.

There was a widespread expectation that the Fed will raise interest rates by a quarter-point. That would be the 10th consecutive increase in the Fed's target for the federal funds rate, the interest that banks charge each other.

The move would push the rate to 3.5 percent, the highest level since August 2001 and more than triple the 46-year low of 1 percent that was in effect before the Fed started raising rates in June 2004.

Although economists once expected the Fed to pause for awhile in its rate hikes, many now believe the central bank will keep pushing rates higher at each of the remaining three meetings this year, leaving the funds rate at 4.25 percent by year's end.

"I think it will be steady as she goes, a quarter-point at each meeting," said David Wyss, chief economist at Standard & Poor's in New York.

The reason for the change of opinion has been an economy that is showing new vigor after a slowdown in the early spring. Overall economic growth, as measured by the gross domestic product, came in at a solid 3.4 percent rate in the April-June quarter, and many analysts believe it is growing at an even faster pace in the current quarter.

The solid growth helped the economy create 207,000 jobs in July, the best showing in three months. Hourly wages rose by 0.4 percent in July, the biggest increase in a year.

That increase in hourly earnings raised concern on Wall Street that the Fed may start to worry about wage increases making inflation worse. In addition to wage pressures, inflation could also worsen from another flare-up in oil prices, which shot up to a record close of $63.94 per barrel in New York trading on Monday.

Some analysts said that while the outcome of Tuesday's meeting is predictable, the debate inside the Fed is likely to be lively with policy-makers divided into two camps.

"There is a split between Fed officials who see inflation potentially stepping up and those who think it is remarkably well-behaved for this stage of the expansion," said David Jones, head of DMJ Advisors, a Denver-based consulting firm.

Jones said that while the debate will not affect the quarter-point move at this meeting, it could influence where the Fed decides to stop raising rates.

The central bank is seeking to push the federal funds rate to a neutral level, where it is no longer stimulating economic growth but is not depressing growth either. Many economists believe that level is somewhere between 3.5 percent and 4.5 percent and where the Fed stops will depend on the central bank's concerns about inflation.

With various signs pointing to stronger economic growth, financial markets have been pushing up long-term interest rates as well, resolving at least partially what Greenspan has termed the "conundrum" that existed for most of the past year in which long-term rates have been falling even as the Fed moved short-term rates higher.

The yield on Treasury's benchmark 10-year note rose on Monday to 4.39 percent, the highest it has been since last April.

The rise in long-term rates has been pushing mortgage rates higher. The 30-year fixed rate mortgage hit 5.82 percent last week, the fifth consecutive weekly increase.

Economists are not looking for mortgage rates to suddenly begin surging. They are forecasting that the 30-year mortgage will be around 6.25 percent by the end of this year and probably around 6.5 percent in the summer of 2006, still a historically low level for mortgage rates.

Housing has been one of the economy's standout performers. Sales of both new and existing homes are expected to hit new record highs for a fifth straight year this year, with home prices soaring as well.

Analysts said the rise in mortgage rates should be enough to dampen sales and put a cap on surging home prices in 2006.

"I think housing will start to slow down as mortgage rates start to tick up," Wyss said.