(Commentary. John M. Berry is a Bloomberg News columnist. The opinions expressed are his own.) By John M. Berry March 15 (Bloomberg) -- Federal Reserve officials seem more likely to pause in raising their target for the overnight lending rate when it reaches 5 percent than to push it up to 5.5 percent as a growing number of Wall Street analysts now predict. A pause after one more quarter-percentage-point increase to a 4.75 percent target, a step everyone expects at the March 28 Federal Open Market Committee, would probably be a better bet than a 5.5 percent target. The analysts are responding to signs that economic growth is rebounding to a 4.5 percent to 5 percent annual rate this quarter amid expressions of concern by some Fed officials that a tightening labor market might cause a pickup in inflation. Most of the analysts also expect growth to continue for some time at a rate high enough to add to inflation pressures. As a group, the Fed policy makers don't share that assessment of the economy. They are not worried about the current rebound partly because they expect growth to ease in the latter half of the year and in 2007. Most Fed officials expect growth will run at a 3 percent to 3.5 percent pace later this year and next year, Fed Chairman Ben S. Bernanke said in congressional testimony Feb. 15. The Fed Board staff has a similar prediction. Growth in that range is about how fast most Fed officials believe the U.S. economy can grow without causing inflation to accelerate. The issue for the policy makers is what overnight lending-rate target is consistent with such growth under current economic circumstances. Slight Drag The current 4.5 percent target is 350 basis points higher than when the Fed began lifting it in June 2004. Moving to a 5 percent target -- adjusted for core inflation -- would mean the effective rate had swung roughly from negative 1 percent to positive 3 percent. Historically, a real 3 percent target would be judged slightly restrictive. With the spread between three-month and 10-year Treasury securities pretty small, some officials think the target ought to be exactly that -- slightly restrictive. On the other hand, based on current readings on inflation and inflation expectations, they don't see any need to crunch the economy, and they don't intend to do that. Besides, with the housing industry cooling off, officials want to avoid overshooting. The increase in the overnight lending rate has caused a jump in the initial rates being charged on adjustable-rate home mortgages, and the rise in longer-term rates has also pushed up rates on 15- and 30-year fixed-rate mortgages. Home Equity Perhaps equally important in terms of consumer spending, the value of outstanding home-equity loans -- many of which are used to finance consumer purchases -- has begun to contract. As the level of sales of both new and existing homes slows and prices either stabilize or decline a bit, equity extraction that could support spending should also decline. According to minutes of the Jan. 31 FOMC meeting, the Fed Board staff expected real GDP growth to slow later this year,``importantly reflecting a reduced impetus to consumption from House price appreciation and some slowing in residential house expenditures.'' Fed officials continue to be surprised, and more than a little pleased that little of the rise in energy prices has found its way into core inflation. They have been similarly surprised and pleased that the drop in joblessness below 5 percent has had little impact on unit labor costs. Steady Growth With hours worked apparently rising at about a 2 percent annual rate this quarter, based on January and February figures, productivity should increase along with the rebound in growth. Even with a small drop in productivity in the non-farm business portion of the economy in the fourth quarter, the increase in unit labor costs last year was only 1.3 percent -- hardly a source of much inflationary pressure. So far there hasn't been anything in the economic data to change the collective view shown in the FOMC's Jan. 31 minutes: ``Over the next couple of years, the economy seemed poised to expand at a moderate rate in the neighborhood of its sustainable pace. Most participants expected core inflation to move up slightly in the near term, reflecting some pass-through of increased energy and other commodity prices. ``Although heightened inflation pressures could also arise from possible increases in resource utilization, the outlook for economic growth and the stability of inflation expectations suggested that core inflation should remain contained over time.'' Stubborn Inflation? The data could, of course, take an unexpected turn that leads the Fed to continue raising rates, or to pause abruptly. Some of the analysts raising their call for where the Fed will pause expect growth to be stronger than Fed officials anticipate, and that inflation will turn out to be more stubborn. For example, economists Richard Berner and David Greenlaw of Morgan Stanley told their clients they now forecast a 5.75 percent lending rate target by September, rather than a pause at 5 percent. ``The key reason,'' they said, is ``dwindling economic slack and escalating costs in the context of strong U.S. andglobal growth.'' As of now, that's not how most Fed officials see it. --Editors: Greiff (jto) Story illustration: For a graph of the Federal Reserves overnight target rate, see {FDTR <Index> GP <GO>}. To chart quarterly changes in the U.S. gross domestic product, adjusted for inflation: {GDP CQOQ <Index> GP <GO>}. To chart changes in personal consumption against growth in GDP, see: {GDPCTOT% <Index> GDP CQOQ <Index> HS 2 Q <GO>}. For more GDP statistics: {ALLX GDP <GO>}. For stories about Federal Reserve actions: {FEDU <GO>}. To contact the writer of this column: John M. Berry in Washington at (1)(202) 624-1962 or jberry5@bloomberg.net To contact the editor responsible for this column: James Greiff at (1)(212) 617-5801 or jgreiff@bloomberg.net
Good article. Berry was the Fed's chosen "leaker" while the G-man was in charge. It looks like things haven't changed since he left. Of course, short term yields plummeted yesterday alolng w/a report by well-connected Medley Advisors that the Fed was about done, so Berry wasn't first in line this time.