US must hike rates by full 1 per cent

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The Independent Online

Interest rates in the United States must be hiked by at least an entire percentage point over the next few months to avoid a destabilising surge in inflation, a leading global economic body warned yesterday.

The Organisation for Economic Co-operation and Development said rates needed to rise to 7 per cent "by the end of this summer" to bring GDP growth down to below 3 per cent in 2001 from the 4.5 per cent it predicts for this year.

But the pessimism was tempered by figures showing a surprise fall in US retail sales in April - the first drop for a year. Shares surged on both sides of the Atlantic on hopes that previous rate hikes may have started to cool the economy.

In its annual survey of the US economy, the OECD said: "Demand continues to outstrip supply, generating a very tight labour market, a widening external deficit and the risk of underlying inflation, raising the economy's vulnerability to business cycle risks.

"To safeguard a continued - if slower - expansion, further increases in short-term rates are needed." But the group said the full extent of the tightening was "uncertain" as the improvements in returns on capital may have lifted the level of interest rates needed to achieve a slowdown.

OECD chief economist Ignazio Visco said: "The American economy is growing very fast, much faster than we thought. Our forecasts could be changed in the next two weeks." Asked whether that meant a possible upgrade from the current 2000 growth forecast of 4.5 per cent, Mr Visco said 4.5 per cent would be "bottom of the band".

News of a surprise 0.2 per cent fall in retail sales gave a fillip to Wall Street, which had expected a 0.4 per cent rise. The Dow Jones and Nasdaq indices, both weak recently, surged.

But economists said one set of data would not alter the Fed's likely decision to hike rates by a half-point to 6.5 per cent next week. Stan Shipley of Merrill Lynch said: "It may be some sign the economy may be slowing but after the data last month and with the overall pace of growth still too strong, unquestionably the Fed will go 50 basis points."

Market strategists said it was only temporary relief for shares. "The market is looking for a reason to rally," said one analyst. "We are still in corrective mode."