Fed plumps for seventh rate rise

Democrats angered by `bucket of ice water on the economy'
  • @IndyVoices
The Federal Reserve yesterday raised short-term US interest rates for the seventh time in a year, in a delicately balanced move to slow the economy's vigorous growth and choke off inflation, but without stopping the recovery in its tracks. After two days of deliberations , the central bank's policy-making Federal Open Market Committee decided to raise the two key rates by half a point, as analysts had overwhelmingly expected. The discount rate advances from 4.75 to 5.25 per cent - its highest level in since September 1991, while the federal funds rate, which banks charge each other for overnight loans, goes up to 6 per cent from 5.5 per cent.

The increases will play a significant role when Kenneth Clarke, Chancellor of the Exchequer, and Eddie George, Governor of the Bank of England, meet this morning to discuss UK interest rates. Failure to match the US move with a third interest rate rise in Britain could put sterling under pressure. UK base rates, if unchanged at 6.25 per cent, will be closer than usual to the key federal funds rate at 6 per cent.

British policy, just as in the US, is geared towards early action on interest rates to keep growth at a sustainable rate and prevent future increases in inflation. The Fed's statement yesterday said the half-point increase was ``necessary to keep inflation contained and thereby foster sustainable economic growth.''

The Fed said its decision came despite what it called tentative signs of slowing growth. Nonetheless, the ecomony was continuing to advance "at a substantial pace, while resource utilisation had risen further".

The US move, so widely anticipated, may be the last for a while. Although the economy produced its best performance for six years in 1994, with national output growing at 4 per cent, according to preliminary Commerce Department estimates, signs are multiplying that the six increases in short-term rates are starting to take their toll.

Retail sales over the important Christmas period showed a surprising decline, as have car and housing sales in the early part of last month. Indeed, the growing fear now is that the Fed may be overreacting to the risk of inflation. "To tighten further now is dangerous," said Larry Chimerine of the Economic Strategy Institute. "The last thing we need is another recession when we haven't fully recovered from the last one."

On Capitol Hill, 20 House Democrats had vainly urged Alan Greenspan, the Fed chairman, to hold his fire. "Leave rates alone," said David Bonior, the minority whip. "To raise them is like throwing a bucket of ice water on the economy."

Market rection was muted. Julian Jessop, international economist at HSBC Markets, said: ``As expected, the Fed cited the desire to nip inflation in the bud.''

There was some disappointment in financial markets that the policy makers had not opted for an even bigger, three-quarter-point, increase. The dollar drifted down immediately after the announcement, falling below the psychological tidemark of DM1.52. US Treasury bonds and share prices on Wall Street scarcely reacted.

The Fed gave no clue of the extent to which Mexico's financial crisis had been a factor in its discussions. Mr Greenspan has been a leading advocate of a rescue package for the peso. But higher US rates will increase the attractiveness of the dollar, andcould place further pressure on the Mexican currency.