Banks should prepare themselves for another increase in short-term interest rates by the Federal Reserve Board, perhaps next month and no later than early autumn.
That is the conclusion drawn by bank economists and others in the wake of testimony by Fed Chairman Alan Greenspan last week before Congress.
Banks have quickly matched the central bank's credit tightening moves up to now, preserving the momentum of their earnings growth and averting any serious slippage in their stock prices. But analysts are divided on whether it will be as easy the next time.
Mr. Greenspan left all his options open, in the best tradition of central bankers everywhere, but seasoned observers said his remarks offer little doubt that rates are going up again.
"He clearly opened the door to credit tightening, but the timing depends on the incoming economic data," said Robert G. Dederick, chief economist for Northern Trust Corp., Chicago.
"If the data are a little soft, the Fed could opt to pass in August and wait until September," he said. "There is an element of water torture here, but I am looking for a move, perhaps several, well before year's end."
So far this year, the Fed has raised the federal funds rate by 125 basis points. It did so in four stages between February and May, mostly after meetings of the central bank's policy-making Open Market Committee. The next meeting is scheduled for Aug. 16.
'Relatively Subdued' Inflation
In his testimony, Mr. Greenspan said inflation was "relatively subdued," but he added: "It is an open question whether our actions to date have been sufficient to head off inflationary pressures and thus maintain favorable trends in the economy."
"Everything the chairman said adds up to a forewarning that the Fed is going to tighten further," said Eugene J. Sherman, research director at M.A. Schapiro & Co. Inc., New York.
"They want the support of data being released between now and the August meeting" of the monetary policy committee, he said. "By that time, they will have another month of industrial production, consumer price, producer price, and capacity utilization figures as well as another jobs report.
"That will allow them to analyze two months of economic developments subsequent to the May 17th tightening," he said. "It will provide an important picture of how the economy reacted to the rate increases of last winter and spring."
Mr. Sherman said Aug. 16 is the "probable timing" of the next tightening. He thinks it is unlikely the central bank will act before then, having already established a very deliberate pattern of action.
A tightening move was widely expected after the open market committee's July meeting, particularly because of the dollar's weakness in foreign exchange markets, but the Fed did not act.
"They don't want to be put in a position of doing something for a particular reason that would be read by the market in a particular way," Mr. Sherman said of the central bank.
"By broadening the focus they avoid trapping themselves into making a forced move or a situation where they might like to make a move but can't" without causing a reaction in the investment community.
Mr. Sherman said he did not think the Fed would hold off from tightening credit in August, if it feels justified, because next month is an important refunding period in the government bond market. Next month, the Treasury will hold its semiannual auction of 30-year bonds.
Jobs Data Could Delay Rise
But a soft employment report for July, to be released in early August, could delay a rise in rates. "The July jobs report could well be on the weak side," said Mr. Dederick.
The June report was strong, but may have borrowed some of that strength from July because of differences in the survey period used by the Labor Department.
If the report is weak, it could signal that the Fed will not tighten for another month, prompting a rally in the bond market, Mr. Dederick said.
A bond rally, in turn, would provide support for banking stocks, which often follow trends in the credit markets.
