Monday, June 16, 2008

Fed to market: Rate hikes-not yet

"Financial markets are in danger of getting carried away with their expectations for Federal Reserve interest rate increases, some senior Fed officials believe.

They do not dispute that the next move in US interest rates is very likely to be up. But they feel the market may be pricing in too much tightening too soon.

Since March there has been a sharp rise in bond yields and expected interest rates, which gathered pace in recent days amid tough talk on inflation by Ben Bernanke, chairman.

Just over a week ago, markets expected just one rate hike of a quarter percentage point before the end of the year. Now they expect three and possibly four.

The more dovish senior officials are not altogether unhappy about the move up in expected interest rates. They think that some increase is appropriate, given the decline in the “tail risk” of a severe recession and stronger-than-anticipated consumer spending.

They hope that the market-driven tightening will help contain inflation expectations, under pressure from record oil prices. But they feel that the swing in market rate expectations may now have gone too far.

There is a difference between the Fed signalling that it will respond aggressively if challenged by rising inflation expectations, and signalling that it intends to tighten policy quite quickly and aggressively even if expectations do not rise further. Fed officials are agreed on the first proposition; they are not agreed on the second.

Some senior policymakers think it is still too soon to be sure that the risks to inflation now exceed the risks to growth.

These officials have not tried to challenge market expectations largely because they think incoming information will clarify whether the Fed should start moving rates up quite quickly."

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