US Fed lifts rates but adopts neutral stance

THE FEDERAL Reserve lifted US interest rates by a quarter of a point yesterday, meeting the market's expectations. It also indicated that this might be the last increase in interest rates for some time, while leaving the door open for further action.

"The Federal Open Market Committee today voted to raise its target for the federal funds rate by 25 basis points to 5-1/4 per cent," it announced yesterday afternoon. "In a related action, the Board of Governors approved a 25 basis point increase in the discount rate to 4-3/4 per cent."

"Today's increase in the federal funds rate, together with the policy action in June and the firming of conditions more generally in US financial markets over recent months, should markedly diminish the risk of rising inflation going forward. As a consequence, the directive the Federal Open Market Committee adopted is symmetrical with regard to the outlook for policy over the near term."

The Fed eased rates three times at the end of last year as it became concerned about the impact of the financial and economic collapse in Asia, Russia and Latin America, but Alan Greenspan, the Fed chairman, has hinted strongly that at least some of this needed to be recouped. However, the signs were yesterday that it was content for the moment that it had shifted far enough.

"With financial markets functioning more normally, and with persistent strength in domestic demand, foreign economies firming and labour markets remaining very tight, the degree of monetary ease required to address the global financial market turmoil of last fall is no longer consistent with sustained, non-inflationary, economic expansion," it said.

At its last meeting, the FOMC decided to raise rates by a quarter of a point to 5 per cent, the first rise in two years and the end of a long cycle of declining rates. It also shifted the bias of policy towards neutral, a sign the markets took as a slight relaxation of concerns about the economy's longer-term future. The Fed next meets on 5 October.

The stock market had apparently been unconcerned about the Fed meeting, and on Monday night Wall Street hit a record high as the Dow Jones industrial average rose 199.15 points to close at 11,299.76. But the basis for this rally seemed weak, with retreating stocks outnumbering advancing ones, and in advance of the Fed announcement the market was down about 40 points.

The Fed's policy has become controversial, with Republican candidates for the party's Presidential nomination arguing that no interest rate rise was necessary. "Deflation is far more of a danger today than inflation, as farmers across the country can tell you," Republican presidential candidate Steve Forbes said on Monday. "Jacking up interest rates now would be a pre-emptive strike against American prosperity, not against inflation."

Iowa, a leading agricultural state, is one of the key political battlegrounds ahead of next year's election. Economic growth has already slowed in the second quarter. Consumer price inflation is running at around 2 per cent per annum, higher than it has been but far from a wage-price spiral. Labour markets are tight but show no signs of exploding out of control, and are very patchy across America.