NEW YORK – The Federal Reserve (search) began a two-day meeting on Tuesday that is widely expected to end with a quarter percentage point increase in official interest rates, ending a period of the lowest rates in two generations.
Financial markets anticipate a hike in the federal funds rate to 1.25 percent from 1.0 percent when the Fed makes its announcement around 2:15 p.m. on Wednesday. It will be the first increase in four years.
The central bank's policy-setting Federal Open Market Committee (search) began its meeting as scheduled at 2:30 p.m., a Fed spokeswoman said.
With little suspense about a rate increase, or the size of the increase, investors will closely watch the Fed's statement for hints about the pace of future rate hikes.
Specifically, analysts are waiting to see if the central bank tempers a promise to raise rates gradually, perhaps with a caveat that if inflation rises more than expected, the Fed will also raise rates more than it currently plans to.
A Reuters survey of the top economists on Wall Street found all 21 expect the Fed to raise rates to 1.25 percent, and to retain the reference to a gradual increase in rates, perhaps with some modifications.
So, what will the Federal Open Market Committee consider at its two-day meeting?
Signs of Inflation
— Price pressures have built some momentum in recent months, but several Fed officials have said most of the factors behind the increase should prove temporary. The core inflation reading favored by the Fed rose by 1.6 percent over the year to May, still within its 1-2 percent comfort zone.
— Employment has picked up strongly in recent months, with 1.2 million jobs created this year. However, a policy brief by the Boston Fed released late on Friday estimated the economy is still more than 5 million jobs short of full employment, which suggests that wage pressures will not add to inflationary pressures for some time yet.
— Consumers may be trimming spending given the prospect of higher rates. Although retail sales jumped 1.2 percent in May, there are signs that consumer spending may be easing as major retailers, like Wal-Mart (WMT) and Target (TGT) reduce their expectations for growth in June.
— Buyers are still rushing into the housing market — sales of new homes surged 14.8 percent last month alone, but refinance activity has fallen sharply.
— Factory activity has ramped up this year, and the Institute for Supply Management's index is not far off a two-decade high in May at 62.8.
What the Fed Has Said
After spooking markets in early June with a remark the Federal Reserve would make more aggressive rate moves if needed to curb inflation, Fed Chairman Alan Greenspan (search) offered a more soothing tone a week later.
"Our general view is that inflationary pressures are not likely to be a serious concern in the period ahead," he said on June 15.
Fed officials have all echoed the same view since the last policy meeting, namely, that rate increases will be "measured."
Waiting Game for Markets
— For weeks, futures markets have been pricing in an increase in the federal funds rate to 1.25 percent after the Fed's policy meeting breaks up on Wednesday, so the only reaction is likely to come if the statement suggests a shift in tone about a "measured" rise.
— The 10-year Treasury note yield has already backed up more than a full percentage point from its low in anticipation of Fed tightening, while the broad S&P 500 index is about 1 percent higher compared with its level after the Fed's May meeting.