Fears grow that Fed could raise interest rates to 6%

Fears grow that Fed could raise interest rates to 6%
Copyright The Financial Times Limited 2006
By Jennifer Hughes in New York
Published: June 23 2006 03:00 | Last updated: June 23 2006 03:00

Fears are growing in financial markets that benchmark US interest rates could rise as high as 6 per cent in a bid to quell rising inflation.

Investment bank Barclays Capital yesterday became the latest of a small but growing group forecasting that the US Federal Reserve would raise rates to a higher level than the market is currently expecting.

The Fed's open markets committee meets next week and is expected to raise its benchmark Fed funds rate by a quarter point to 5.25 per cent. Most analysts believe that the June move, or perhaps one further move in August, will mark the peak in the bank's rate rising cycle.

But Barclays Capital economists said: "We have become less convinced that the FOMC will be comfortable keeping rates at 5.5 per cent in August as growth remains strong and core inflation continues to move higher.

"We now project that the FOMC will raise the Fed funds rate to 6 per cent this year."

Fed funds futures, a gauge of the market's expectations, have swung sharply this month. August contracts currently price in an 80 per cent probability of a quarter-point rate rise in that month, as well as the quarter-point rise expected next week.

Interest rate-sensitive two-year yields yesterday reached their highest since December 2000 at 5.247 per cent - just shy of next week's expected Fed funds target.

Dealers cited speculation that the Fed could surprise the market with a half-point point rise rather than quarter point rise next week. "We think that there is a notable chance of a 50 basis point rate hike at an upcoming meeting," Barclays said yesterday, although they felt such a move was more likely in August.

Last week, economists at Lehman Brothers raised their Fed funds forecast to 5.75 per cent. Others with a 6 per cent peak include JPMorgan and Credit Suisse, although both expect to see that some time next year.

But others fear the Fed will be tightening policy in a slowing economy, worsening the slowdown. "If the Fed were to choose to chase the peak [in inflation], then the funds rate could be headed for 6 per cent - which we think would be a big mistake," said David Rosenberg, chief US economist at Merrill Lynch.