Fed Expected to Boost Rates by 1/4 Point

With a fall in oil prices easing inflation concerns, the Federal Reserve (search) is expected to continue its easy-does-it approach to raising interest rates, boosting a key rate by a moderate quarter-point at its final meeting of the year Tuesday.

Many analysts believe this pattern of gradual quarter-point rate increases will continue well into the new year. Solid economic growth and an absence of inflation pressures mean Federal Reserve Chairman Alan Greenspan (search) (search)and his colleagues can take their time in moving away from exceptionally low interest rates.

"The essential picture the Fed sees is a well-balanced and sustainable economic expansion. It has the leeway to continue its measured steps," said economist David Jones, the author of four books on the Greenspan Fed.

The federal funds rate (search), the interest that banks charge on overnight loans, is now at 2 percent, up from a 46-year low of 1 percent, where it stood before the Fed began nudging rates higher on June 30.

Short-term consumer rates have been heading higher at the same gradual pace. Banks' prime lending rate (search), the benchmark for millions of consumer loans, is now at 5 percent, up from 46-year low of 4 percent before the Fed began raising rates.

Even with a rate increase Tuesday, the funds rate and the consumer rates tied to it will still be at historically low levels. Fed officials have said they are trying to gradually raise the funds rate to a "neutral" level where it is neither promoting stronger economic growth nor depressing growth.

Many economists believe that level of the funds rate would be somewhere between 3 percent and 4 percent.

When oil prices were soaring to above $55 per barrel in October, some analysts said the central bank would feel the need to accelerate its rate-tightening moves if it appeared that the big jump in energy prices was threatening to push overall inflation rates higher.

However, oil prices have retreated significantly from those highs, trading at around $41 per barrel currently, a move that has helped ease concerns about inflation.

On the growth side of the ledger, there had been concerns earlier in the fall that a sputtering job market would force the Fed to put its rate hikes on hold for a while. But October job growth surged by 303,000 and the November figure, while lower, showed a still respectable increase of 112,000 jobs.

Analysts said the Fed will continue monitoring the economy closely and keep nudging rates up slowly as long as job growth continues and inflation remains moderate.

"What the Fed does will depend on what the inflation and employment numbers do from month to month," said David Wyss, chief economist at Standard & Poor's in New York.

All analysts said they expected little change to the Fed's statement explaining its actions. They looked for the central bank to continue to pledge to move at a "measured" pace in raising interest rates and to express a belief that the risks to the economy going forward were equally balanced, giving equal weight to the possibility that growth would be slower or that inflation might be higher than expected.

The Bond Market Association (search) predicted Monday that the current 2 percent federal funds rate will be at 3.5 percent by the end of next year, with the expected Tuesday rate hike, the fifth in the series, to be followed by five more rate hikes.

These modest rate increases will allow the economy to keep growing next year at an annual rate of 3.7 percent, down only slightly from this year's expected 4.4 percent increase, the Bond Market's economic forecasting panel said.

"The story of the U.S. economy continues to be one of sustained growth in an environment characterized by recent oil price swings and a falling dollar," said Robert DiClemente, the vice chairman of the forecasting panel and the head of U.S. economic analysis at Citigroup.

Because rate hikes have so far been gradual, there has been very little impact on long-term interest rates such as mortgage rates. In fact, after hitting a high for the year of 6.34 percent in early May, 30-year mortgages have been trending lower as the bond market responded to the economy's pronounced summer soft patch, reflecting the adverse impact of higher oil prices.

Last week, Freddie Mac reported that the national average for 30-year mortgages had fallen to 5.71 percent.

Jones said he believed, even with further Fed rate hikes, 30-year mortgage rates should still be around 6 percent to 6.5 percent at the end of 2005, helping provide support for another strong year for the housing industry.