The U.S. Federal Reserve Board raised interest rates by 25 basis points today, and economists expect the rate hiking to continue.

Today’s hike was the tenth consecutive increase by the Fed. The fed funds rate now sits at 3.5%, up from 1% in June 2004.

Bank of Montreal notes that, despite the increase in rates, policymakers still believe the current level remains accommodative,” hinting at further tightening ahead. “The pace of future rate increases is ‘likely to be measured’, that is, limited to increments of 25 basis points at upcoming policy meetings,” BMO predicts.

TD Bank notes that the tone of the communiqué was essentially the same with some minor tweaking of the text. “Among them, the Fed noted that aggregate spending appears to have strengthened since late winter, which is a slightly more bullish statement on economic conditions than in the previous communiqué, which stated that the ‘expansion remains firm’,” it observes. However, it notes that the Fed remains committed to the view that longer-term inflation expectations remain well contained, monetary policy remains accommodative, and that policy accommodation can be removed at a pace that is likely to be measured.

“So, the conclusion seems obvious. The Fed will continue to raise rates to a more neutral setting, which traditionally has been about 4.50%,” TD says, adding that markets largely expect this future tightening too.

“This is not an economy in need of accommodative monetary settings, leading us to believe the Fed will continue to hike rates at every policy meeting scheduled this year. In all, another 75 basis points are on deck for the remainder of 2005, with odds favouring one last 25 basis point hike in early 2006,” TD says.

National Bank Financial suggests that the Fed will more closely monitor the behaviour of wage inflation for possible pass trough into core inflation measures. It also sees no pause in sight in Fed tightening through the yearend (which takes the rate to 4.25%). “Looking ahead to 2006, the big question will be whether the Fed will be content with a neutral policy or will need to move into restrictive territory,” NBF notes. “Expect more soul searching from capital market participants. For the time being, we are sticking with our 12-month target of 1225 for the S&P 500 and almost 5% on the 10-year note.”

BMO is a bit more cautious, it predicts just two more 25-basis point rate increases at the September 20 and November 1 policy meetings. “This will take the funds rate up to 4.00%, three percentage points higher than at the start of the current tightening cycle. After November, the Fed will likely pause to assess the impact on the economy of both higher interest rates and higher oil prices,” it says. “The tightening cycle should resume in the summer of 2006, eventually taking the funds rate to a more neutral level of 4.5% by the fall of that year.”