Fed raises US interest rates by 0.5% with 'more to come'

The US raised interest rates by half a point yesterday, emphasising fears that exceptionally strong growth could hit the American economy.

The US Federal Reserve also warned that the threat of inflation was not going away, alerting markets to the likelihood of further increases.

The Federal Open Market Committee raised its target for the federal funds rate by 50 basis points to 6.5 per cent, and also boosted the discount rate by 50 basis points to 6 per cent. It acted because of a future threat of inflation might dent the US economy, not because price rises were already evident.

"Increases in demand have remained in excess of even the rapid pace of productivity-driven gains in potential supply, exerting continued pressure on resources," said the Fed in a statement.

"The Committee is concerned that this disparity in the growth of demand and potential supply will continue, which could foster inflationary imbalances that would undermine the economy's outstanding performance."

The Fed also made it clear that it did not believe that the need for tightening was over, and that its bias in the future would be towards further interest rates rises.

"Against the background of its long-term goals of price stability and sustainable economic growth and of the information already available, the Committee believes the risks are weighted mainly toward conditions that may generate heightened inflation pressures in the foreseeable future," it said.

Prices were steady in April, according a new report from the US Labor Department which showed the Consumer Price Index stable for the first time in a year. A steep rise in the CPI in March of 0.7 per cent, stoked by rising energy and transportation costs, had shocked financial markets. But since then oil prices have levelled out. Core CPI rose by 0.4 per cent in March, but its rate of increase slowed to 0.2 per cent in April.

The interest rate rise had been well-expected, and the half-point rise had been largely discounted. However stocks pared gains on the announcement, with the benchmark Dow Jones Industrial Average shedding 103 points of a 155 point gain on the day to trade at 10,860 within half an hour of the announcement. The Nasdaq Composite index, dominated by hi-tech stocks, also retreated to stand at 3636, up 28, as the Fed's signals of further rate rises were digested.

"Not too many people thought that they'd make a strong grumpy statement to go with the announcement," said Henry Hermann at Waddell & Reed Financial Services in California. "I don't think the negative comments were priced in the market."

The Fed has raised rates in five quarter-point increases since June 199, having cut rates the year before in response to the market turmoil in Asia and Russia.

The annualised rate for US inflation is 3.0 per cent, an upward tick which shows a steady rate of price increases. But it is not inflation which - as yet - is concerning US policymakers: it is the tightening of labour markets as unemployment falls below 4 per cent, creating bottlenecks in some sectors. Economic growth is powering ahead at more than 5 per cent a year.

The next Fed meeting is on 27-28 June, and traders will now expect further action. Some estimates see US interest rates rising to 7.5 per cent by the end of the year.

The half-point move would bring borrowing costs to their highest level since early 1991. The prime rate, set by the banks on the basis of the Fed's rates, stood at 9 per cent before the Fed's decision, and is expected to rise to 9.5 per cent, its highest level in nine years.