How many rate hikes does economy need?

Many analysts say Fed will lift interest rates just once more in 1999,

There could be another speed bump ahead for the US economy.

Tomorrow, the Federal Reserve Board may try to slow the economy with another 1/4-percent rise in interest rates - a move that many believe would be the last rate rise of the year.

The rate hike is expected to have more of a psychological impact on the economy than a real effect. Such a hike would signal to Wall Street that the Fed is unhappy with the zip in the economy and concerned about possible inflation. Yet most believe the hike would have little practical impact.

Mortgage rates already reflect the expectation of the higher rates and a 1/4-point increase in rates is not likely to keep consumers from car lots or shopping malls. In addition, the stock market has already factored in the presumed August hike.

"The real question is whether the Fed needs to tighten later this year or beyond," says economist William Sullivan, with Dean Witter Morgan Stanley in New York.

If the Fed decides it needs to hike rates again at its October meeting, the stock and bond markets might feel a downdraft.

"A stiff correction in the market is apt to have a curbing effect on the economy - more than the actual rate increase," adds Mr. Sullivan.

Mixed economic signs

So far there are only scattered signs that the economy is responding to the last rate hike at the end of June. Housing is starting to slow as mortgages get more expensive. For the moment, consumers, perhaps slightly more apprehensive, appear to be backing off some. But the US job machine is humming and business is still scampering to fill orders.

Because of the mixed signs, economists believe the Fed will have a tough call. "The economic numbers are a little hard to interpret," says Lyle Gramley, a former Fed governor.

For example, inflation numbers, which came out last week, don't indicate any price spiral. The July consumer price index (CPI) showed a 0.3 percent increase, mainly fueled by higher tobacco and gasoline prices. Excluding food and fuel, inflation rose at 0.2 percent - a pace acceptable to Fed Chairman Alan Greenspan.

"One can make a case that not too much tightening of monetary policy is necessary," adds Mr. Gramley, a consulting economist at the Mortgage Bankers Association in Washington. The Fed may opt to keep rates the same but announce it has a "bias" toward tightening - a way to warn the markets it is considering a rate hike, says Gramley.

But most economists believe the Fed will act now. When the July unemployment rate was issued two weeks ago, many economists believe the numbers indicated a lathered-up economy. In addition, productivity gains appear to be slowing. In the past, most companies have been able to increase production, without higher costs because of productivity gains.

"I think the Fed will say they need to raise rates one more time - to tweak things," says Robert MacIntosh, chief economist for Boston-based Eaton Vance Management.

A correction for Asia

Economist Don Hilber of Wells Fargo & Co. in Minneapolis thinks the Fed may rationalize a rate hike by noting that it lowered interest rates three times last year when it was worried about the Asian collapse. Now that Asia's economies have stabilized, a second rate rise could be explained as taking back some of the previous cuts.

"It's not putting the screws on the economy," he says.

But other economists feel the Fed might want to wait to see how much the second quarter gross domestic product (GDP) is revised. A preliminary look showed the GDP growing at a 2.3 percent annual rate, down from 4.3 percent in the first quarter. With imports surging into the country, the revised GDP numbers may show a much slower economy than anticipated.

Gerald Cohen, senior economist for Merrill Lynch & Co. in New York, estimates that the GDP will be revised to a 1.8 percent annual growth rate because of imports.

"The drag on US growth from deteriorating trade is intense," says Mr. Cohen

Despite the fact the economy will have a weak quarter, Merrill Lynch's computer model indicates that Mr. Greenspan will tighten interest rates because of the Fed's fear of potential inflation, says Cohen.

"The Fed is concerned there will be too much pressure on firms to raise wages because of the low unemployment rate. A rate hike will take the edge off the labor market," he says.

Last chance in October

The Fed won't have much more data to look at before its next meeting in October. There will be one set of inflation numbers, the August unemployment report, and the second-quarter GDP revision.

But that might be the last opportunity for the central bank to increase rates because of the approaching millennium.

"There's an argument that if the Fed acts, it should do it as soon as possible so you're through the end of the year - a period of stress - with a stable policy backdrop for the financial markets," says Sullivan of Dean Witter.

(c) Copyright 1999. The Christian Science Publishing Society

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