President Bush, by proposing Thursday to spend billions of government dollars on Gulf Coast reconstruction, made it very likely that the Federal Reserve will raise short-term interest rates next week, economists said yesterday.
The extra federal spending to help Hurricane Katrina victims build new homes, communities and lives will boost national economic growth in coming months. That should help offset the short-term slowdown caused by higher energy prices and the storm's destruction of jobs, buildings, roads, ports and production facilities.
But that extra stimulus, coming as the economy is expanding strongly and unemployment is low, also will fan inflationary pressures, analysts said.
That gives the Fed one more reason to move up its benchmark short-term interest rate Tuesday, and possibly to raise it higher than it otherwise would next year to make sure inflation stays under control.
The president's plan, estimated to be worth $200 billion, "certainly does add to the case for the Fed to hike rates," said Ethan S. Harris, chief economist at Lehman Brothers Holdings Inc. "The package is so big, there is a significant chance you'll end up with both higher growth and higher inflation next year."
At their meeting Tuesday, Fed officials also will consider leaving unchanged their benchmark federal funds rate, the overnight rate charged on loans between banks. They have raised it 10 times in the past 15 months -- it is now 3.5 percent -- and indicated at their last meeting in August that they would move it higher in coming months to avoid fueling inflation.
Many analysts predict the Fed will stop after lifting the rate to around 4.5 percent sometime next year. But some also said yesterday that the central bank may have to raise the rate even higher because of the coming burst of federal spending. The rate influences many other interest rates charged to consumers and businesses.
The uncertain economic outlook would be one reason for Fed officials to pause in their series of rate hikes. Much of the government's most recent economic data was collected before Katrina struck. Fed officials can't know how many people will be unemployed for how long because of the destruction, or how high energy prices will be in coming weeks.
Fed policymakers are particularly concerned about how sharply consumers will curtail spending and businesses will raise prices in response to higher energy costs. A University of Michigan survey released yesterday showed that consumer sentiment plunged after Katrina to its lowest level since 1992, while expectations of higher inflation jumped.
Several Fed officials had noted before Bush's announcement that government spending in response to the crisis in Louisiana and neighboring states -- then estimated at $50 billion -- would help cushion the storm's national economic impact.
They observed that the economy had been in robust form before Katrina and emphasized their inflation worries -- a sign they were already leaning toward another rate hike.
Officials also were encouraged by signs of recovery in the Gulf Coast. Oil production is being restored gradually. The Port of New Orleans reopened last week, months earlier than people expected immediately after the storm. U.S. benchmark crude oil closed yesterday at $63 a barrel after soaring above $70 immediately after the hurricane hit, toppling rigs, closing refineries and clogging pipelines.
Gasoline prices fell to a national average of $2.89 a gallon yesterday, down from a post-Katrina peak of $3.06 on Labor Day, according to AAA.
The surge in energy prices "should be manageable for consumers," John Fernald, vice president of the Federal Reserve Bank of San Francisco, said in an analysis Monday. He noted that employment and incomes are rising, and that gasoline spending accounted for just about 3 percent of consumer spending in the spring.
"An economy running at full tilt should be able to weather the recent energy shock, though possibly with an unpleasant short-term bump," Fernald wrote.
Ben S. Bernanke, chairman of the President's Council of Economic Advisers and a former Fed board member, said in a speech Thursday that energy price increases appear to have had a "relatively modest" effect on economic growth so far.
Meanwhile, Fed officials have worried that inflation is running at the high end of their comfort range.
Former Fed board member Laurence H. Meyer, vice chairman of Macroeconomic Advisers LLC, predicted yesterday that the Fed will raise the federal funds rate to 3.75 percent Tuesday. He was convinced over the last week, he told clients, by "evidence of even stronger momentum in growth before Katrina hit, a significant reversal of the initial rise in gasoline prices, and dramatically higher projected federal spending on relief and reconstruction."