Fed increases rates to brake US economy

In a sudden, but hardly unexpected, jab on the brakes, the Federal Reserve yesterday added a quarter point to short-term interest rates. It was the first move by the Fed to tighten US monetary conditions in over two years.

There was little surprise on Wall Street, which had been conditioned to expect a small increase in rates by recent comments from the Fed chairman, Alan Greenspan. The federal funds rate - the rate that commercial banks charge each other for overnight loans - was raised from 5.25 to 5.5 per cent.

Mr Greenspan has recently repeatedly expressed concern that the US economy, now in its sixth year of expansion, might be exceeding the speed limit. By putting rates on an upward course, he will be hoping to dampen the economy's power somewhat and pre-empt any return of inflationary pressures.

Until yesterday, the Fed had not raised rates since February 1995; nor had it changed them in either direction for 15 months. Though modest, the increase should be felt by millions of US consumers with some form of debt, for instance in mortgage, credit card or shop loans.

"It is exactly the right thing," commented Robert Dedrick, a former US under-secretary for commerce. "If they hadn't moved today we would have been asking whether the Fed was ever going to act."

Few analysts believe either the stock or bond markets will be much hurt by the quarter-point increase. Mr Dedrick cautioned, however, that the markets "are going to be quite vulnerable", if the Fed raised rates over the short term by anything more than half a point. The Dow Jones fell slightly on the news, closing 29 points down at 6,876.17.

There was no agreement among economists on whether the hike would turn out to be a one-off move by the Fed or only the first in a string of incremental increases. "This will not be the last tightening," suggested James Griffith of Aeltus Investment Management.

Donald Straszheim of Merrill Lynch was among those not seeing a long run of interest rate increases. "I think the answer is no," he said, predicting that one or perhaps two quarter-point increases would keep the economy in equilibrium.

Had the Fed not moved, the credibility of Mr Greenspan might have been on the line. In recent testimony to the US Congress, he made plain his concern that the continued strength in the US economy threatened to tighten the labour market, push up wages and thereafter prices. In a statement, the Fed said it was acting "in the light of persisting strength in demand, which is progressively increasing the risk of inflationary imbalances developing in the economy that would eventually undermine the long expansion".

The "slight firming of monetary conditions it views as a prudent step that affords greater assurance of prolonging the current economic expansion".

Predictably, the rate change drew some early political fire. Democrat Senator Tom Harkin criticised the move saying it would slow the economy unnecessarily, reduce government revenues and hamper efforts to balance the budget.

Current indicators show little to cause alarm.

Inflation in the first two months of the year stood at 2.3 per cent compared with 3.3 per cent for all of last year.