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Fed meets on rate hike amid global pressure for caution

[WASHINGTON] The US Federal Reserve opens a two-day meeting Wednesday to weigh what could be a historic interest rate increase amid global calls for caution as world economic growth slows.

The World Bank has warned developing economies to prepare themselves for more capital and currency market turmoil while the OECD urged the Fed to move slowly and make its policy plans clear, whatever it decides.

Most analysts saw the Fed again putting off the long-awaited increase to the benchmark federal funds rate, which has been locked at zero since the 2008 crisis, giving the world a massive supply of cheap dollars.

While US growth has been strong, still-weak inflation and the recent China-driven turmoil in global markets "most likely mean that the FOMC will leave rates unchanged at this week's meeting," said Harm Bandholz of UniCredit.

The Fed has not raised rates in more than nine years, and what would probably amount to an increase of 0.25 percentage point would represent a momentous break with the extraordinary crisis stance it has adopted since the 2008-2009 recession.

It would begin what is expected to be a slow series of rate hikes towards a "normal" monetary policy stance of around 3 per cent in the next two years.

But it would also make the dollar more expensive and hike borrowing costs for developing economies around the world.

The policy-setting Federal Open Market Committee, led by Fed Chair Janet Yellen, will announce a decision at 1800 GMT Thursday. Yellen will then address the media, with analysts saying her justification will be as crucial to markets as the decision itself.

Having jumped back and forth in recent weeks, world stock markets were mostly higher Wednesday, with the Japanese Nikkei average adding 0.81 per cent, the pan-Europe Euro Stoxx 50 adding 1.09 per cent, and New York's S&P 500 edging up 0.48 per cent.

The dollar slipped to $1.1300 against the euro but rose against the yen, to 120.54 yen.

By most assessments the US economy, with unemployment at 5.1 per cent and moderate growth, is strong enough now that holding the rate at zero percent is no longer warranted.

But to many economists, the slowdown of global economic activity, particularly in China, now poses a risk to US growth and an interest rate hike could set the economy back.

The World Bank warned Tuesday of a "perfect storm" of dangers, including a freeze in capital flows, for developing countries as the Fed tightens policy.

"Given the substantial risks involved, they would do well to buckle their seatbelts in case the ride gets bumpy," said Carlos Arteta, lead economist in the Bank's Development Prospects Group.

Earlier Wednesday the Organisation for Economic Cooperation and Development, the policy club of 34 advanced economies, said the strength of the US economy "warrants an upward interest rate path." "The timing of the first rate hike is of secondary importance compared to the pace of increase. Clear communication of that pace will help to minimise financial market volatility."

Still, having already endured substantial turmoil and capital outflows, a number of leaders from emerging markets economies have urged the Fed to end the suspense and make the hike.

But the FOMC also has to be concerned with whether an unexpected slowdown in the US economy could then force it to backtrack, undermining its credibility.

Wednesday's US consumer price index report showed inflation still very weak. However, noted Chris Low of FTN Financial, "While some of us think inflation is too low and likely to remain that way, most of the FOMC strenuously disagrees."

AFP