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NEW YORK (Reuters) - The Federal Reserve will keep U.S. interest rates steady through 2008, median forecasts in a Reuters poll showed on Thursday, a sharp change from a month ago when they pointed to a quarter point cut later this year.
That retreat from expectations for lower rates has been reflected in U.S. government bond yields, which in recent weeks have surged to five-year highs in a broad worldwide sell-off.
Bonds have undergone a "dramatic turn in market sentiment, due in part to a shift in Fed rate expectations," said Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities.
The median of forecasts from the poll, conducted June 11-14, now sees the Fed maintaining the Fed funds rate at 5.25 percent throughout this year and next.
Last month the median forecast was for the Fed to cut rates in the fourth quarter and then hold them at 5.0 percent through the end of next year.
Of 115 economists polled on rates for this year, 68 are now looking for the Fed to keep them steady at 5.25 percent through to year-end. That comes despite no change to full-year median forecasts for either growth or inflation this year and next.
Thirty-eight of them still see one or more rate cuts while nine say rates will hit 5.50 percent or higher by year-end.
The Fed has held rates at 5.25 percent since June 2006 and the market is playing catch-up. A recent rout in bond prices has pushed benchmark yields, which normally are higher than base rates but have been lower for a long time, to within a few basis points of the fed funds rate.
Economists have generally described this as getting market rates back to more normal levels rather than the beginning of a new chapter of higher rates in the U.S.
The shift is based in part on expectations of higher interest rates globally, but also on some signs the U.S. economy is growing at a faster pace than originally expected.
Also, economists are forecasting that core inflation will remain above the central bank's presumed comfort zone of one to two percent.
Indeed, bond yields have risen steeply since last week when Fed Chairman Ben Bernanke said the U.S. economy is set to grow at a sluggish pace in coming months but emphasized there were risks that elevated levels of core inflation may not recede.
The core consumer price index (CPI), which does not include food and energy costs, is expected to rise by 2.3 percent in 2007 and by 2.2 percent in 2008, according to the poll.
While above the Fed's preferred range, those CPI expectations were unchanged from a poll one month ago. The latest data for May are due on Friday and economists expect core inflation to hold steady at 2.3 percent.
But the tide has shifted on rates.
"There has been a realization of how strong world economic growth is and the likelihood that many of the central banks globally are going to continue to raise rates, and the U.S. gets dragged into that," said Joseph Shatz, government bond strategist at Merrill Lynch Government Securities in New York.
Merrill last week slashed expectations for 100 basis points worth of Fed rate cuts by year-end to none. Goldman Sachs, which had pencilled in 75 basis points worth of easing this year, also got out the eraser last week.
Economists expect growth to pick up steam, forecasting 2.2 percent overall growth this year and 2.9 percent next year, unchanged from the previous poll.
The government estimated late last month that U.S. first quarter growth increased at a 0.6 percent annualized rate, which was the weakest in more than four years.
Additional reporting by Bangalore Polling Unit, Ross Finley in London