Ben Bernanke has had a tough initial period as the most powerful central banker in the world. When he came in, markets believed that he would be less hawkish on inflation than his predecessor Alan Greenspan. His earlier statements and testimonies reinforced this perception

Stock and bond market traders widely believed till early May that the Fed was close to ending its regime of interest rate hikes. Bernanke soon disabused them of the nation when he stated publicly that traders and analysts had misread him. That made the markets jittery. A more hawkish statement, "increases in inflation are unwelcome" soon followed.

Before becoming the head of the US Federal Reserve Bernanke, like many academics, had urged the US Fed to be more transparent with its policy outlook. The argument was that the markets spend a lot of unproductive time trying to figure out changes in Fed policy. If the Fed was more open with its views, the markets could easily anticipate its future moves by reading key economic signals.

This is a major change from the days of Alan Greenspan, who was famous for his use of complicated language to explain Fed policy. Deciphering Greenspan-speak had become a cottage industry in Wall Street when he was in charge of the Fed for 18 years.

Entering an uncertain zone US monetary policy during the last few years under Greenspan was predictable. Economic growth was strong and inflation was modest and the Fed maintained its over-cautious stand and went on hiking interest rates by 25 basis points. From a 4-decade low of just 1 per cent in mid-2004, the Fed hiked rates 15 times by 25 basis points each before Greenspan stepped down earlier this year.

The environment is much more uncertain now with the US economy showing clear signs of a slowdown when inflation is inching up on high energy prices. This has brought back fears of a stagflation - rising inflation when economic growth is slowing down - after a very long gap.

A vast majority of economists and analysts expect the Fed rate to go up by another 25 basis points, considering the up trend in consumer price inflation. US employment growth remains strong with unemployment rate below 5 per cent and consumer confidence has not seen any perceptible decline. The economic slow down is only at its initial stages and there is no consensus as yet on the extent of the slowdown.

A very small number of economists have forecast a 50-basis point hike today, arguing that slow measured steps over the last two years have not yielded the desired results. This is not very likely as Bernanke would not like to disrupt the economic momentum of the US economy at this point and inflation expectations have not yet gone out of hand.

Not many pointers on future course of interest rates are expected in the policy statement following the rate announcement. Like any prudent central banker, Bernanke would also prefer to play it safe and keep his options open as long as the economic environment remains uncertain.

Impact on markets A 25-basis point hike may not have much of an impact on the markets as it has already been factored in. Equity markets across the globe have corrected substantially over the last month and a further decline is unlikely after a modest rate hike.

An unlikely 50 basis point hike would most certainly lead to further weakness as it would be a clear indication that the Fed is much more concerned about inflation than expected. There is also a small possibility that a large hike would be interpreted by the markets as a sign that the Fed was likely to pause for a while.

Today's Fed statement and the minutes of the meeting that will be released later would be more important from a market perspective on hopes that they may possibly contain some clues to the future moves by the Fed. An absence of any clear statements would lead to further uncertainty in the short term.

When would Bernanke stop? This is undoubtedly the single most important question in global financial markets these days. And there are no easy answers.

Though the Fed has been hiking rates for almost two years now, it is still around the long-term average rate. A 25-basis point hike to 5.25 per cent per annum would take the Fed rate marginally above its long-term average.

As interest rates have been fairly below historical average, the rate hikes have not impacted economic growth so far. The big unknown is the point at which a further rate hike would significantly affect economic momentum.

Minutes of the last few Fed meetings reveal that a number of Fed governors are reasonably convinced that the current rates are closer to the elusive 'equilibrium rate'. However, if inflation continues to inch up, the Fed would be forced to take interest rates higher.

How much further can the Fed go? Fed rates hit a historic high of 19 per cent in 1981 under Fed chairman Paul Volcker, who resorted to substantial rate hikes to fight double-digit inflation. Inflation in the US today is nowhere as alarming and nobody expects it to go anywhere hit double-digits either.

Most of the Fed rate hike campaigns in the past have resulted in economic recessions. Paul Volcker faced heavy criticism in the early '80s as the US economy slipped into the worst recession since the Great Depression. Even Alan Greenspan saw the US economy declining twice in his term after interest rate hikes. This time around the Fed would be much more concerned about an economic recession. Besides, in a much more globalised world, the risk of runaway increases in inflation is relatively low as global trade has increased substantially. Shifting of manufacturing and service delivery to low cost locations like China and India has kept global inflation under control to some extent.

Consensus forecasts put the Fed rate around 6 per cent per annum by early next year. Rate hikes beyond this level would most certainly lead to a recession, according to some surveys among economists. More optimistic analysts expect the Fed to stop around 5.5 per cent by August this year. Once again, much would depend on prices of crude oil and other commodities.