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Fed may shun "gradualist" rate hike pace

 NEW YORK (Reuters) - The last time the Federal Reserve was raising interest rates, it did so at a snail's pace. But it may not take that gradual approach to tightening policy the next time around.

Fed officials are stressing there will be no exit from the U.S. central bank's extraordinarily accommodative interest-rate stance for an "extended period" and analysts do not expect the first rate hike until 2010 or 2011.

The U.S. central bank slashed its benchmark overnight borrowing costs close to zero last December as part of an emergency rescue of the U.S. economy that included a raft of extraordinary lending and purchase programs, such as buying mortgage-related debt.

Fed watchers say it would be able to keep its low-rate pledge more easily if it were perceived as ready to move up quickly when it finally does begin to tighten.

In its last rate-raising cycle from mid-2004 to mid-2006, the Fed increased the overnight federal funds rate by a slim quarter point at each of 17 consecutive meetings.

This deliberate policy, known as "gradualism," aimed to be predictable so as not to disrupt markets. In a 2004 speech, then-Fed Governor Ben Bernanke, now the central bank's chairman, discussed reasons for gradualism, as well as an alternative, which he called the "cold turkey" approach.

Many economists believe the decision to raise rates at a "measured" pace after a long period in which they were unusually low kept monetary policy too easy for too long, fueling the housing bubble that led to the current crisis.

Chicago Federal Reserve Bank President Charles Evans said last week that the pace of tightening was "perhaps a little too measured."

The Fed would want be more aggressive next time, he said.

"We are probably in a period where gradualism is less important than getting to the right stance in policy," Evans said.

To be sure, the first hike won't mean policy has suddenly become restrictive. With rates currently near zero, it would simply start taking them to a more normal base.

Indeed, the Fed may not turn aggressive until it is clear the economy needs more restraint.

"Once they decide it's time to go for broke, it's unlikely you'll see the baby steps you saw in 2004 to 2006," said Mark Gertler, a professor at New York University and a visiting scholar at the New York Federal Reserve Bank.

Interest rate futures markets, however, are pricing in a relatively gradual approach to rate hikes. While the first increase fully priced in is a relatively large half-point move in June 2010, the market sees rates up to only about 1.25 percent by the end of the year.

Of course, any decision to raise rates will depend greatly on how the economic recovery plays out.

Fed officials have warned that the recovery will be slow and tentative. At the annual Fed conference in Jackson Hole, Wyoming, officials from both the Fed and the European Central Bank stressed they were in no rush to exit their accommodative policies.

Of course, raising interest rates is not the only way the Fed could begin to withdraw its economic supports.

Reversing some of its unorthodox lending and purchasing measures would be another way for the central bank to start moving policy back toward a more neutral stance.

 

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