(RTTNews) - Rising inflation and a slowing economy have put Ben Bernanke and his fellow Federal Reserve members in an especially delicate position as they try to decide which is a greater threat to the U.S. economy. Most experts believe the Fed will hold steady at the meeting, although the Fed’s statement will be scrutinized for clues as to where interest rates are heading.

The threat of inflation has grown in recent months as soaring commodities prices, specifically record oil prices, have prompted many to call on the Fed to begin raising interest rates in an effort to curb inflation. However, lingering weakness in the economy could prevent the Fed from raising rates as concerns that pulling that switch prematurely could put the economy on track for a more pronounced slowdown.

The two-day FOMC meeting began Tuesday, and the Federal Reserve will make their announcement Wednesday afternoon.

Due to the dueling pressures of rising inflation and a still-struggling economy, the majority of experts are predicting no change in the federal funds rate. There has been a call from some hawkish commentators for the Fed to reverse its recent course and raise rates, although lingering problems in the labor markets make this unlikely.

There has been a fierce debate within the Fed over the proper course for monetary policy. Hawkish Federal Reserve Bank Presidents Jeffrey Lacker from the Richmond Fed, Richard Fisher from the Dallas Fed, Charles Plosser from the Philadelphia Fed, and the new addition James Bullard from the St. Louis Fed have appeared strict on inflation, citing it as their chief concern in many speeches. Both Fisher and Plosser, FOMC voting members, have dissented at the previous two FOMC meetings when the Fed decided to cut rates. The central bank has reduced the federal funds rate 325 basis points since September, when it stood at 5.25 percent, to its current level of 2 percent.

Recent statements from the Fed have signaled an end to its recent rate cutting cycle. In the minutes from the April meeting, which took place on the 29th and 30th, the Fed stated that only a significant weakening of the economic outlook should move policy makers to further cut rates. In April the U.S. central bank cut the federal funds rate by a quarter percentage point, bringing it to 2 percent. The minutes revealed that the decision to cut was a “close call.”

“Most members viewed the decision to reduce interest rates at this meeting as a close call,” the minutes read. “Although downside risks to growth remained, members were also concerned about the upside risks to the inflation outlook, given the continued increases in oil and commodity prices.”

Lindsey Piegza, economic analyst for FTN Financial said the market expects the Fed to raise rates eventually, though they likely will not be able to do it yet.

“Expectations of a crummier economy and rising prices underscore the difficult position of the Fed, she said. “The market expects the Fed to raise rates, restoring strength to the dollar and squashing inflation,” she noted, but added, “However, as the economy continues to erode with strapped consumers and pressure remaining on the credit markets, an increase in rates may only exacerbate the problems on the other side of the equation.

Piegza concluded, “The Fed’s corner surrounded by still wet paint is much smaller.”

Recently, lingering problems in the housing and credit markets along with soaring energy prices contributed to the cut in the Fed’s growth forecast. In February, the Fed had forecast gross domestic product growth between 1.3 and 2 percent. The Fed slashed that forecast at the April meeting, now predicting GDP growth between 0.3 percent and 1.2 percent in 2008.

They are also expecting higher unemployment, between 5.5 percent and 5.7 percent this year. Previously, the upper end of the Fed’s forecast had unemployment set at 5.3 percent.

Rather than continue to lower interest rates, the Fed will likely wait and see if the impact of its rate cuts, combined with the economic stimulus will give the economy a boost. Inflation was clearly an area of concern, as rising food and energy prices that have boosted headline inflation threaten to trickle down to push up core inflation.

Inflation is now expected in the range of 3.1 to 3.4 percent this year, a full percentage point higher than the old forecast of between 2.1 percent to 2.4 percent in 2008. However, several top officials have said that if oil prices continue to defy expectations in their record setting run, the inflation outlook could be drastically altered.

In keeping with recent comments from several Federal Reserve officials, the FOMC expects that economic activity will pick up in the second half of the year. Although many have predicted that the pick-up will still leave growth quite sluggish, by 2009 the Fed is expecting the impact of its interest rate cuts and the economic stimulus to normalize GDP.

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Posted in Categories: Economy, Forex, Releases, USA.

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