Doubts creep in about Fed rate hike on Tuesday

Mon Aug 9, 2004
By Victoria Thieberger

NEW YORK, Aug 9 (Reuters) - The vast majority of Wall Street economists expect the Federal Reserve to go ahead and raise borrowing costs at its policy meeting on Tuesday despite recent weak economic data, but a brave few are breaking with the consensus belief.

Two well-regarded economists, from Wrightson ICAP and Royal Bank of Scotland, said on Monday they predict the central bank will hold steady on interest rates on Tuesday until the doubts over the economic "soft patch" have lifted.

"It makes more sense to exercise caution when the economic uncertainty is greatest," said Wrightson ICAP's chief economist Lou Crandall.

"As a result, we think the Fed is likely to defer its next hike until a meeting where the economic outlook is less cloudy," Crandall wrote in a note to clients.

That outlook runs against the majority of Wall Street economists, who say the Fed will want to follow up its sole rate increase in June as part of its plan for a "measured" pace of tightening to get the 1.25 percent federal funds rate back to more normal levels.

On Friday, a discouraging increase of just 32,000 payrolls on July, the second weak month in a row, was not enough to sway the top bond dealers on Wall Street.

A Reuters survey found all 20 economists still expected the Fed to push ahead with a quarter-point rate increase to 1.50 percent, despite the slowdown in hiring and consumer spending.

The Fed last month played down the weakness in June as temporary, but the payrolls report showed the softness persisted in July.

Though the Fed rarely shifts course in response to a single number, Crandall points out that Friday's payrolls report was "two weak numbers rolled into one".

Although he was optimistic about a recovery over the remainder of the year, he cautioned: "There are enough warning signs (in consumption, capital goods orders and now employment) to suggest that there are significant risks to that forecast."

Fed Chairman Alan Greenspan's modus operandi has been to take into account the risks surrounding any given forecast, such as the view that the economy will soon bounce back.

Ram Bhagavatula, chief economist for North America at Royal Bank of Scotland in New York also believes the Fed won't raise rates on Tuesday. He noted that the economic data, released since Greenspan said a few weeks ago that the "soft patch" in June was "transitory" has been worse than expected.

Consumer spending is weakening, core inflation is tame, oil prices are at record highs, stocks are at their lowest levels for the year and, against a backdrop of rising terrorism concerns, volatility and uncertainty remain high.

"The Fed's concerned with the economy," Bhagavatula said, dismissing the suggestion no move from the Fed on Tuesday might cast doubt over its assessment of the economy and even call into question its credibility.

"It's worse for their credibility if they raise and then have to cut," he said, though he doesn't think that's likely to happen.

The slowdown in the economy may be more severe than the Fed had anticipated, noted Nigel Gault, economist at Global Insight. "We now expect the Fed to pause on August 10 and await more evidence, before moving again."

Futures markets were still leaning with the majority, pricing in a 65 percent chance of a Fed rate rise on Tuesday.

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