Mixed signals on the US economy have put the Federal Reserve in a quandary as it tries to steer monetary policy amid fresh inflation concerns but also a slumping housing market, analysts say. The central bank's Federal Open Market Committee headed by Ben Bernanke is widely expected to hold its base interest rate steady at 5.25 percent at a two-day meeting opening Tuesday.
The federal funds rate has been unchanged since August, when the Fed halted a string of 17 quarter-point increases. But policymakers have warned in the past few meetings that they are watching inflation and could hike rates again to keep prices in check.
The hotter-than-expected inflationary pressures have become evident with a stunning 1.3 percent jump in February's producer price index (PPI) and a 0.4 rise in the consumer price index (CPI).
This has disappointed those who have been waiting for Bernanke's predicted "moderation" in inflation that could allow the Fed to cut rates to stimulate a sluggish economy.
The latest inflation reports "do not permit the Fed to soften its stance on inflation risks, at least not yet," said Stephen Gallagher, economist at Societe Generale.
"The Fed anticipates a reduction of inflation and over time we agree. The problem is that the decline is not fast enough to give the Fed manoeuvring room at present."
Gallagher said the FOMC meeting "should be an opportunity to repeat the status quo - no rate changes and a risk bias that inflation could be higher than expected."
Later this year, assuming inflation eases, Gallagher predicts the Fed will cut rates twice in 2007 for "insurance" against recession, but may have to do more if the economy fails to gather momentum.
But some experts are abruptly reassessing their forecasts in the wake of the meltdown in the subprime mortgage sector, the riskiest part of the housing market, amid rising defaults in loans to people with poor credit histories.
A key question for the Fed is whether the problems are contained or lead to a wider contagion that affects the broader economy.
Goldman Sachs economist Andrew Tilton said he believes the woes in the housing sector will have "an important spillover" that hurts consumer spending, leaving the economy growing at a weak 2.0 percent pace for most of the year, forcing the Fed to change course.
"Further weakening in the housing market and a slowdown in spending should contribute to labor market weakness in coming months," Tilton wrote in a note to clients.
"We expect sufficient deterioration to prompt Fed easing by midyear, pushing the funds rate down to 4.50 percent by the end of 2007."
Tilton said he cannot rule out a more grim scenario involving a "credit crunch" that spreads to the mainstream banking sector, but says a recession is "less probable."
The Fed, in its latest Beige Book report, cited some pockets of slowing activity in the economy but said the expansion is continuing. But the Fed is still predicting US gross domestic product growth (GDP) in a range of 2.5 to 3.0 percent for 2007.
Comments
Comments are closed.