The US Federal Reserve is likely next week to raise its target federal funds rate to 1.75 per cent from 1.5 per cent, nearing the end of the first stage of what appears to be a two-stage plan to return rates to "normal" levels, the Wall Street Journal said yesterday.

The article by Fed-watcher Greg Ip contained no direct attribution to Fed officials. But Ip has made enough correct calls on central bank policy to make financial markets highly sensitive to his reports.

The Fed is expected to announce any decision on rates next Tuesday at 1815 GMT.

The newspaper said the first phase of Fed tightening will cause the funds rate, charged on overnight loans between banks, to rise to two per cent between next week and the Fed's December meeting. It had stood through June at a 46-year low of one per cent.

After December, the Fed, whose chairman is Alan Greenspan, will try to raise the rate to a more "neutral" level, probably between three per cent and five per cent, that neither stimulates nor restrains growth, the newspaper said.

The speed of these increases will depend more on new economic data, especially oil prices, it said.

Recent public comments by Fed policymakers imply there will be less urgency to raise the funds rate as it approaches three per cent, the newspaper said.

It said a rate between two per cent and 2.5 per cent appeals to officials for at least two reasons.

First, it removes much of the "emergency" loosening from 2001 to 2003 in response to terrorism, corporate scandals and deflation fears.

Second, any rate of 1.75 per cent or higher will be above the underlying inflation rate, now about 1.5 per cent, for the first time since late 2001. This makes the inflation-adjusted funds rate, or "real" rate, positive. In contrast, a zero or negative rate might foreshadow higher inflation.

In addition, the newspaper said a slightly positive real funds rate gives the Fed more room to cut rates in case the US economy faces an external shock. It also puts the Fed in line with more non-US central banks.