Fed set to push rates higher: US Reserve Board could plunge markets into chaos

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The Independent Online
THE US Federal Reserve Board is set to raise its key interest rates in a move that threatens to plunge world financial markets into a renewed tailspin.

As evidence mounts that the US expansion is becoming unsustainably strong, analysts predict the Fed will act this month to protect its anti-inflationary credibility in the financial markets.

Before the end of the month, they predict the Fed will raise the Federal Funds rate, the leading market rate, by as much half a point from the current 3.25 per cent. This could be accompanied by the first increase in the US discount rate, now 3 per cent, in nearly five years.

A further increase in US rates could spell fresh turmoil in global bond and equity markets, and may complicate plans for lower rates in the UK and continental Europe.

The Fed last raised rates on 4 February, lifting the Fed Funds rate a quarter point to 3.25 per cent. This was the first such increase in nearly five years. Steep falls in world bond and share markets followed, and analysts worry that another increase could trigger renewed market upheaval.

Neil MacKinnon, chief economist at Citibank, said: 'Higher interest rates are never good for bonds and stocks, and with the Bundesbank putting rate cuts on hold, there is a real risk that the bloodbath in the markets will continue.'

Speculation of an early tightening in US monetary policy mounted on Friday after a much larger than expected surge in US February employment, despite the harsh winter weather. Non-farm payroll employment climbed by 217,000 and followed a report of strong growth in US factory orders. Despite some uncertainty over distortions in the jobs report, both reports raised fears of an outbreak of fresh inflation pressures with the economy running out of spare capacity and threatening to run into bottlenecks that could fuel inflation pressures.

US economists believe the trend rate of US growth, at which there is little or no upward pressure on inflation, lies between 2 and 2.25 per cent. The US economy surged by an annualised rate of 7.5 per cent in the fourth quarter and, to date, figures for the first quarter suggest the annualised growth rate has only subsided to between 3 and 4 per cent - firmly above the sustainable level.

Allen Leslie, a leading 'Fedwatcher' with Discount Corp of New York, said: 'The financial markets are telling the Federal Reserve that the quarter-point tightening in February was either ill-timed or too small. Therefore the Fed will be almost compelled to make a move this month.'

Jane Edwards, of Lehman Brothers International, said: 'The evidence is building up that despite distortions like bad weather and the LA earthquake, the first quarter is running at above trend growth.'

Michael Strauss, another Fed watcher at Yamaichi International (America) Inc, said: 'We are in a bear market, the economy is growing strongly and so the bottom line is not a question of if the Fed will tighten, but when.' Mr Strauss warned that the Fed may have acted too late to prevent higher inflation - which is currently running at 2.7 per cent. 'They are tightening too slow, not enough, and too late in the cycle.'

The Fed's policy-making Federal Open Market Committee, the FOMC, meets on 22 March, and most analysts expect that meeting to authorise an increase, if one is not decided on before then.

Mr Leslie said: 'Now that we've gone into the tightening mode, the Fed will want to be very, very certain of what it is doing. It is not likely to raise rates without a full meeting of the FOMC.'

Agreeing with other analysts that a rate rise was likely this month, Mr Leslie also argued that the Fed was most unlikely to wait until its next meeting on 17 May.