Economists See Slow, Steady Fed Tightening

Wall Street's top economists are pretty sure the Federal Reserve (search) can stick to its pledge to make "measured" increases in interest rates, a Reuters survey found Wednesday.

After the U.S. central bank increased the federal funds rate to 1.25 percent from 1.0 percent, its first hike in four years, the poll found 22 Wall Street economists were nearly unanimous in expecting another modest quarter percentage point rise at the Fed's next policy meeting in August.

Just one economist saw a larger move on the cards.

By the end of this year, the median forecast is for the federal funds rate (search) to rise to 2.0 percent, with forecasts ranging from 1.75 percent to 2.25 percent.

"The Fed may be more cautious this year than the market is anticipating, and they may be more inclined to step up the pace next year as they gain confidence in the momentum behind the economy," said Jim Glassman, senior economist at J.P. Morgan (JPM) in New York.

The key for financial markets was that the Fed's statement accompanying the rate rise retained a pledge to make "measured" increases, which investors interpret as quarter-point moves.

The Fed did add an escape clause, saying it will respond to the economy as needed, which could open the door to more aggressive moves, but analysts had widely expected such a caveat since Fed officials have said the same thing in recent weeks.

The central bank's statement Wednesday included a sanguine view on inflation to support its rate outlook.

"It suggests the Fed's models are predicting very low inflation and that the Fed believes that -- even though some in the financial markets were beginning to fear higher inflation," said HSBC (search) chief U.S. economist Ian Morris in New York.

The Fed's language on Wednesday soothed some market fears of a more dramatic half-point rate rise at the next policy meeting in August, as futures markets scaled back the chances of such a large move.

"The emphasis is on the inflation numbers between now and then, and we would need to see potentially 0.2 percent increases in core inflation or certainly 0.3 percent to justify a half-point increase," said UBS economist Jim O'Sullivan in Stamford, Mass.

The economy has been growing for 11 straight quarters and employment has improved, adding to expectations in financial markets the Federal Reserve has only just begun to move interest rates back to a more neutral level that does not add as much stimulus to the economy.

For September, economists were divided, with 10 expecting another rate rise and nine of those polled seeing the Fed standing pat.

"There's an elephant creeping into the room that people are ignoring, and that is some of the recent economic news is hinting at some moderation," said J.P. Morgan's Glassman.

Peering ahead into next year, the Reuters survey found economists expect the fed funds rate to continue its gradual advance to around 3.75 percent at the end of 2005, according to median forecasts.

Wednesday's rate increase brought to an end a year of the lowest borrowing costs since 1958, a period that has helped underwrite economic growth by fueling a surge in borrowing and spending.

Consumer debt levels have increased to $9 trillion, with more than one-third of that accumulated over the four years since the Fed last raised interest rates.

Still, about four-fifths of this debt is at fixed rates and will be unaffected by the rate increase. Variable rate debt, which will increase in coming weeks, includes rates charged by credit card companies.