Fed Eyes Another Rate Hike

There may be debate over its timing but not over the goal of Federal Reserve Chairman Alan Greenspan and his colleagues: higher interest rates to make sure the economic expansion doesn't generate inflationary pressures.

It would be the 11th straight rate hike, reports CBS News Correspondent Barry Bagnato, and that will push rates for credit cards, home equity lines and some mortgages up, too.

"Consumer spending has held in quite nicely despite rising interest rates, said Bankrate.com financial analyst Greg McBride, but "there's a lot of concern about the sustainability of that consumer spending if the Fed continuers to raise short-term interest rates."

While most economists still believe the central bank will nudge rates higher by a quarter-point at Tuesday's meeting, there are some who think the Fed will pause until it can get a better read on how Hurricane Katrina and the surge in energy prices that followed the devastating storm will affect the economy.

"Unless inflation goes away, the Fed will be active at least once more this year," said McBride.

Many analysts think the biggest threat to the economy — soon to celebrate the fourth birthday of its expansion — lies with consumer spending. It accounts for two-thirds of total economic activity and could falter under the impact of soaring energy prices.

Adding to those worries: Consumer sentiment, as measured by the University of Michigan's consumer sentiment index, plunged by a sharp 12.2 points, according to a preliminary reading of sentiment in September. That tied the biggest one-month drop ever recorded by the index and surpassed the decline experienced after the September 2001 terrorist attacks.

With Americans' savings rates already at a record low, the concern is that consumers might become much more cautious, especially after seeing dramatic pictures of people who have lost everything and must now start over.

"This is a situation where the uncertainties have suddenly become huge," Lyle Gramley, senior economic adviser to Schwab Washington Research Group, said Monday. "If all the concerns translate into much lower personal spending, then the economy could falter."

The Fed is being buffeted by a variety of forces. One of the Fed's concerns is a Katrina-induced slowdown in economic growth caused by a sharp cutback in consumer spending. There is also a concern that the sharp spike in energy prices will spark inflation. The Fed sees its primary mission as keeping inflation under control.
Mark Zandi, chief economist at Economy.com, said that the Fed may well want to move now and perhaps pause at the next meeting, in two months.

"In November, there will be a lot of ugly economic data out on Katrina's initial impact and that might make it harder for them to move at that time," Zandi said.

Greenspan, expected to retire early next year, will have only three more meetings after Tuesday's. That could prove to be a factor in whether the Fed moves this week or not, said David Wyss, chief economist at Standard & Poor's.

"Greenspan is coming to the end of his term and he really wants to get the interest rate increases done before he leaves," Wyss said. "He may feel he can't afford to take a meeting off."

The Fed started raising rates in June 2004 when it pushed the federal funds rate, the interest that banks charge each other, up from a 46-year low of 1 percent. Ten quarter-point moves later — the last one occurring on Aug. 9 — the funds rate going into Tuesday's meeting stood at 3.5 percent, the highest it has been since early September 2001.

"Home equity lines of credit have moved up in almost a parallel fashion to the rising Fed funds rate," said McBride.

Commercial banks' prime lending rate, the benchmark for millions of consumer and business loans, stood at 6.50 percent before Tuesday's Fed meeting, also the highest level in four years.

Even if the Fed decides to take a breather this week in its rate increases, analysts believe it will be only a temporary pause as long as the economy regains its footing quickly after the blow from Katrina. Many analysts believe that Greenspan wants to see the funds rate somewhere around 4 percent to 4.5 percent by the time he adjourns his final Fed meeting on Jan. 31.

That is the day that Greenspan's term as a Fed board member ends. The central bank recently said that the first rate-setting discussion of 2006 would take place on just one day rather than Jan. 31-Feb. 1 to avoid having the meeting span the terms of two Fed chairmen.