Fed seen holding rates steady despite worries

09/20/2006

Wednesday September 20, 12:33 AM EDT

By Tim Ahmann

WASHINGTON (Reuters) - U.S. Federal Reserve officials are expected to hold interest rates steady on Wednesday, but they are also seen renewing an inflation warning even while taking stock of cooler economic growth.

A decision to stand pat with the benchmark federal funds rate at 5.25 percent would extend the rate “pause” policy-makers delivered when they stepped to the sidelines on August 8 after a two-year string of 17 straight rate increases.

Economists say that decision has been validated by signs of slower economic growth and data indicating some easing of inflation pressures.

Minutes of the Fed’s August session showed officials felt the decision to hold borrowing costs steady was a “close call.” Fed watchers say they likely will feel more comfortable now.

“The tightening cycle is over. The Fed is done,” declared Mark Zandi, chief economist at Moody’s Economy.com.

But the policy-makers are not expected to hang up their inflation-fighting spurs just yet and a statement outlining their decision due around 2:15 p.m. (1815 GMT) is expected to hold out the prospect that rates could move higher still.

“The bottom line is this: With inflation too high, policy must have a bias toward further firming,” San Francisco Federal Reserve Bank President Janet Yellen said last week.

Yellen, like many other Fed officials, has said she wants core inflation, which strips out volatile food and energy prices, in a 1 percent to 2 percent range.

But the Fed’s favorite core price measure, the price index for personal spending, rose 2.4 percent in the 12 months through July, and economists said the central bank will likely brandish the threat of higher rates until clearer signs emerge of inflation falling back toward their “comfort zone.”

WAITING FOR THE TURN

While analysts look for the Fed to restate that “some inflation risks remain,” they also expect it to nod to the sharp slowdown evident in the U.S. housing market and the big drop in crude oil prices since policy-makers last met.

Oil prices, which hit a high of $78.40 a barrel in July, settled at $61.66 in New York trade on Tuesday, the lowest since March 21.

Lower energy costs should help ease pressure on other prices and give consumers some support even as cooling home prices undercut them elsewhere.

In the latest sign the long-hot U.S. housing market has fallen back to earth, the government said on Tuesday that housing starts plunged 6 percent in August to more than a three-year low.

That data, coupled with news of a drop in core producer prices in August, buttressed a growing view in financial markets that the next move for U.S. interest rates is down, even if the Fed is not yet ready to say so.

“I think we’re in pause mode for some time to come,” said Peter Hooper, chief U.S. economists at Deutsche Bank Securities. “Our view is that we’ll see a rate cut early in the spring—that the economy will be softening enough to shift the risks in that direction.”