Federal Reserve’s Next Move? All Bets Are Off

After two-plus years and 17 consecutive interest rate hikes before calling off its campaign, is the pain from the Federal Reserve’s long anti-inflation push over for good? Borrowers finally got a reprieve this month when the Fed decided to halt (at least temporarily) the longest stretch of increases in recent history.

Where the Fed is headed next, at its next meeting September 20 and later, is already generating debate. Chairman Ben Bernanke (right) and his colleagues plan to dictate their interest rate policy by lifting rates enough to subdue inflation, but not so much that the strategy hurts the economy.

In other words, it’s a fine line.

The prime interest rates controlled by the U.S. central bank directly influence the rates applicants pay on Florida home mortgages. While the economy is slowing in Florida and throughout the U.S., inflation remains outside the comfort zone of some economists and Fed policymakers.

At its last meeting, on August 8, the Fed held steady at 5.25 percent an important rate. As a result, commercial banks’ prime interest rate — for certain credit cards, a home equity line of credit and other loans — held steady at 8.25 percent.

Given that the U.S. housing market is losing more steam and companies are showing caution in hiring, some economists at the conference said the Fed should keep to the sidelines in the months ahead. That would give the Fed time to assess how the most recent moves in a rate-raising campaign that started in June 2004 are affecting economic activity.

Diane Swonk, chief economist at Mesirow Financial, believes the Fed will not change rates at its upcoming September gathering.

“I think they will stay on the sidelines for a while,” she said.

If the economy continues to lag, Swonk said there is a chance the Fed might cut rates in December or early next year. Options include:

• Boosting rates to fend off inflation.
• Slashing rates to shore up a shaky economy.
• Holding rates steady, buying policy makers more time to assess which risk is greater, inflation or a weaker economy.

Not everyone is confident that the Fed is looking in the right direction.

Allan Meltzer, a professor at Carnegie Mellon University, has questioned whether it was wise for the Fed to halt its credit-tightening campaign with inflation on the rise.

“The Fed may be on the verge of a very big mistake,” he said.

Meltzer is concerned that inflation could creep higher and that the Fed might lose some of its inflation-fighting credibility with investors. Then investors, companies and consumers might alter their behavior in ways that could worsen inflation. For instance, companies might boost prices even more and workers might demand larger pay increases as a result.

“It is hard for me to believe that inflation will come down without further policy action,” said R. Glenn Hubbard, Professor and Dean of the business school at Columbia University.

Economists and investors will have more insight into the Fed’s thinking when minutes of its August 8 meeting are released Tuesday. Upcoming reports on the economy also may help shape opinions on the fate of rates. A reading on economic growth in the April-June period comes out Wednesday.

The Fed believes America’s slowing economy eventually will ease inflation pressures. Yet lofty energy prices are a concern and are under close watch by the Fed. They were the main culprit for the 0.4 percent rise in consumer prices in July, twice the increase in June.

If the Fed holds rates steady or decreases them, that could mean good news for prospective Florida mortgage applicants. Stay tuned, because if these predictions are accurate, the rates that have declined for five weeks in a row now may fall even further by the end of this year.