Fed continues to tighten with further quarter-point rates rise
The Federal Reserve pushed its key short-term interest rate up by a further quarter percentage point yesterday and - to some surprise in financial markets - gave no specific indication that the sequence of 13 consecutive such increases is close to an end.
In a move heavily signalled by its own top officials and universally expected by markets, the Fed boosted its federal funds target rate to 4.25 per cent from the previous 4 per cent. Of far more significance however was the language of the statement accompanying the move.
The word "accomodative" - suggesting that rates were designed to spur growth - has disappeared from the statement, a possible sign that the central bank considers the new rate close to the so-called "neutral level" and that further rises might not be needed. But in the next sentence it seemed to signal that rates would continue to climb. "Some further measured policy firming" was likely to be needed, the Federal Open Market Committee statement said, to keep the balance between promoting growth, and fighting inflation.
"This is a two-handed statement," the former Fed governor Alan Blinder said. "Accomodative is gone, but the rest is not the sort of thing you'd say if the next increase is going to be the last." Yesterday's session of the policy-setting was the next to last before Alan Greenspan, after a reign of over 18 years, hands over command of America's central bank to Ben Bernanke on 31 January next year.
The expectation is that under Dr Bernanke, himself a former Fed governor and, until now, chief economic adviser to George Bush, there will be at least one more increase of 25 basis points - if only to prove the new chairman's inflation-fighting credentials. But after the change of language, experts are split on whether the Fed would stabilise rates at 4.5 per cent or move them higher still, to 4.75 or even 5 per cent.
The FOMC said that despite high energy prices and the disruption caused by the Gulf hurricanes, the economy appeared "solid". Inflation had also remained relatively low but "possible increases in resource utilisation as well as elevated energy prices have the potential to add to inflation pressures." The committee's decision was unanimous.
Since mid-2004, when the benchmark short-term rate hit a 45-year low of 1 per cent, there have now been 13 straight increases of 0.25 per cent. The strategy has paid off, with GDP growth forecast at 3.5 to 4 per cent for 2005. Inflation meanwhile stands at just 1.8 per cent, according to the Fed's preferred indicator, the personal consumption index.
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