The Hindu Business Line : US interest rates: Fed likely to pass

As ever, financial markets the world over are all eyes and ears for the current meeting of the Federal Open Market Committee (FOMC), which decides US interest rates.

In recent days, FOMC members, led by its (and the Fed) Chairman, Mr Ben Bernanke, have started to sing a different tune.

They are saying that it cannot be taken for granted that rates would go down further from the present 2 per cent, despite the weak and declining economy. Mr Bernanke thinks interest rates are now low enough to spur the economy. Inflation is a bigger risk.

The CPI has increased to more than 4 per cent in the last year, thanks to higher energy and food prices. Stripped of these two components, the picture is reassuring.

Core inflation, as this is called, is about 2 per cent — well in the Fed’s comfort zone.

Much as Mr Bernanke would prefer an inflation target (as mandated for the ECB and the Bank of England), consensus on this key issue continues to elude the Fed. In any case, it was inopportune to introduce one amidst the financial crisis of the past year, when the US central bank had to work overtime to safeguard the liquidity and solvency of the financial system. They still remain the Fed’s priorities in the near future. We are not out of the woods as far as the health of global financial institutions and investment banks is concerned. The Fed may yet have to mount a rescue act.

Mr Bernanke has succeeded in giving the market interest rate jitters (if that indeed was his intention, as is possible). The change in sentiment is so sharp that talk now is of the FOMC raising rates very soon.

Is it likely? The economy is still in the doldrums. Job destruction shows no sign of reversing. Business and consumer sentiment indices are on a downward path. And no housing recovery is in sight. It keeps weighing down activity in the rest of the economy.

As energy and commodity prices hit the roof, the Fed’s hope is that they do not feed into general inflation. Its calculation is that the seeds of a fall in inflation are contained in pattern of current inflation itself.

Thus the FOMC’s post-meeting statement will express inflation concern but anticipate the slowing economy will drive it lower.

That seems a prescription for no rate change at this meeting. The Fed could also signal that it is done with its softening stance for the present.

With the interest rate prop off, markets must look elsewhere (energy, commodities, housing and credit markets, corporate performance) for direction.

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