Fed Signals Next Move Will be a Hike in Rates, But Timing Remains Uncertain

By Jennifer Yousfi
Managing Editor

The next move from the U.S. Federal Reserve will be to increase the Federal Funds rate, although the timing of that hike remains to be decided.

“A number of participants worried about the possibility that core inflation might fail to moderate next year unless the stance of monetary policy was tightened sooner than currently anticipated by financial markets,” according to the minutes of the Federal Open Market Committee’s Aug. 5 meeting released yesterday (Tuesday).

The FOMC voted to slash interest rates seven times from 5.25% last September, before voting to hold steady at the current 2.0% rate at the last two consecutive meetings.

While it seems clear the Fed is anticipating a change in course to a tighter monetary policy in order to battle inflation, the majority of FOMC members still feel weak economic growth remains the larger threat in the near-term.

“There is a big split on the FOMC, no doubt about that,” Lyle Gramley, a former Fed governor and senior economic adviser at Stanford Group Co. in Washington, told Bloomberg News. “We know there is a severe credit crunch, but it is difficult outside the housing market to pin down how much impact it is having on the economy.”

Gross domestic product (GDP) showed improvement with a 1.9% rate of growth in the second quarter, however, unemployment hit 5.7% in July, its highest level in four years. On the inflation front, the year-over-year increase for producer price index was 9.8% in July, the highest level in 27 years. Meanwhile, the consumer price index increased 5.6% year-over-year for the month.

One FOMC member feels the inflation numbers are the more troubling of the two. Dallas Fed President Richard Fisher has repeatedly lobbied for a more hawkish stance on inflation and voted to raise the key interest rate at the last meeting.

“While the financial system remained fragile and economic growth was sluggish and could weaken further, [Fisher] saw a greater risk to the economy from upward pressures on inflation,” the minutes read.

Still, with 10 members of the committee having voted to hold rates steady, and only one member voting to increase rates, it seems likely the FOMC will hold rates steady into 2009 before making future moves.

“If anything I read this as the vast majority preaching patience as far as inflation,” Stuart Hoffman, chief economist for PNC Financial Services Group (PNC) told CNNMoney.com.

“The Fed does seem to be signaling their next move is up. But to me the odds of even a December hike are still pretty slim,” he said.

News and Related Story Links:

• Bloomberg News:
  Fed Officials Agree Next Rate Move Will Be Increase

• CNNMoney.com:
  Fed worried about inflation and slowdown

• Reuters:
  Fed saw weak U.S. growth, financial stress-minutes

• Money Morning:
  Federal Reserve Holds Rates Steady at 2.00%, Says “Downside Risks” and Inflation Remain Concerns