Fed expected to inch rates higher today

WASHINGTON -- The Federal Reserve is expected to raise interest rates a quarter-point today, but with job creation at a near standstill many economists believe the Fed will then put its credit-tightening campaign on hold until after the November elections.

That marks a change from the previous consensus that the Fed, when it raised rates for the first time in four years on June 30, was setting the stage for gradual rate hikes at every Fed meeting for the rest of the year.

The change is being prompted by Friday's unemployment report, which showed the economy managed to create just 32,000 new jobs in July, the smallest monthly job increase this year and far below the 200,000-plus jobs that economists had been expecting. It was the most dramatic sign yet that the economy had hit what Federal Reserve chairman Alan Greenspan had earlier termed a "soft patch."

Most analysts believe the Fed will not see the weak July performance as an indication that the economic recovery is in danger of stalling, noting that other indicators of July activity, such as auto sales, have shown a rebound after a disappointing June.

"I think the Fed will see this as a temporary setback that they don't expect to last," said Sung Won Sohn, chief economist at Wells Fargo in Minneapolis.

When the Fed nudged its federal funds rate, the interest banks charge each other, up from a 46-year low of 1 percent to 1.25 percent, it announced that it believed future rate increases could be made "at a pace that is likely to be measured."

At the time the Fed took its action, the economy appeared to be racing ahead. But since then a variety of reports have shown that the big spike in oil prices this year caused consumers to dramatically cut back on spending and raised questions among businesses about their hiring plans.

After Friday's unemployment report, Wall Street took a beating. The Dow Jones industrial average and other major stock barometers fell to their lowest levels of the year because of investor concerns that the economy's slowdown could turn into something worse.

Many analysts said the main reason they believe the Fed will go ahead and raise rates by a quarter-point this week is that if the Fed failed to make the widely expected increase, investors would worry that the economy is in even worse shape.

After today's expected hike, analysts said, the Fed may well decide to take a pause, especially if the economy hasn't shown clear signs of rebounding when the Fed next meets on Sept. 21, the last rate meeting before the November elections.

Economist Lyle Gramley, a former Fed board member, said the central bank will be strictly guided by the economic numbers in determining what to do in September because the meeting will take place in the heat of a presidential campaign.

"The election puts the Fed in a difficult position. If the economic data strengthens and they don't tighten, they would be accused of trying to re-elect George Bush," Gramley said.

The concern among analysts is that the economy will not strengthen in coming weeks as consumers and businesses continue to struggle with soaring energy prices.

Economists said they will be watching closely to see if Fed policy-makers give any hint on how they view the jump in energy prices. Greenspan has indicated that he views the energy increases as temporary and so far presenting little threat of adding to overall inflationary pressures, but that view could change with the renewed upward climb of oil prices.

On the other hand, the Fed may view the rise in energy prices as a significant restraint on economic growth, which would put a damper on overall price pressures.

Greenspan said in his midyear report to Congress last month that should inflation threaten to become a bigger problem than currently expected, the Fed would not hesitate to abandon its "measured" pace and begin to move interest rates up more aggressively.