Fed rate hikes near end, say bank economists.

The Federal Reserve is expected to raise interest rates a quarter point at the next FOMC meeting in the face of continuing inflationary pressures, the American Bankers Association Economic Advisory Committee said recently.

"The Committee forecasts the economy to grow at a 3 percent rate--at best--for the remainder of the year," said Robert T. McGee, EAC chair, chief economist, U.S. Trust Company, New York. "This slowing should give the Fed some breathing room to allow the cumulative effects of previous rate hikes to set in."

The Committee believes that the Fed is likely to stop at 5.25 percent. However, the recent pick-up of core inflation has injected a new element of uncertainty and could move the Fed to a further increase later this year.

"Anchoring inflationary expectations has been a top priority," said McGee. "Further rate increases, however, raise the risk of a bumpier landing in 2007 as the economy may slow more dramatically."

Inflation will level off for the remainder of this year and moderate in 2007 as the economy slows, according to the Committee's forecast.

"Globalization and technology-induced productivity growth are helping to offset the pass-through of high energy costs on core inflation," said McGee. "Assuming oil prices stabilize, inflationary pressures should abate."

The EAC forecast reflects housing starts and home sales decreasing slowly through 2006 and 2007. However, the Committee acknowledged the downside risk to the forecast if home building and sales decline more dramatically.

Consumer spending growth will average less than 3 percent as elevated oil prices and higher interest rates squeeze discretionary income, said the Committee. Moreover, housing will be less supportive of consumer spending going forward.

"These headwinds will mean that consumer spending will no longer be the engine of growth that it has been over the past decade," said McGee. "Business spending and eventually net exports will be carrying more of the load in keeping output and growth near potential."

Business capital investment will grow at a rate of 9 percent in 2006, according to the Committee's forecast. As a result, demand for business loans will continue to grow, with the Committee forecasting commercial and industrial loans to increase 10.6 percent in 2006 and 8 percent in 2007.

The economists do not see a dramatic, disruptive rise of interest rates, with short-and long-term rates firming up only about one-third of a percentage point by the end of next year. According to the forecast, conventional mortgage rates will reach 6.8 percent in 2007.

The trade deficit is expected to stabilize over the next 18 months, the Committee said. Given its size, however, the trade deficit remains another risk as it could precipitate a disorderly decline in the dollar.

The EAC meets in Washington twice a year to provide perspectives on the national and local economies to top policymakers. The group met with governors of the Federal Reserve Board and the Chairman of the Council of Economic Advisors.

Information for this article was provided by the American Bankers Association.