The US Federal Reserve held its benchmark interest rate at a 45-year low yesterday, but sent its strongest signal yet that a series of modest increases is all but certain to start within the month or two.
The decision was the first in a crucial week for monetary policy that sees three other central banks for the UK, the eurozone and Australia set rates amid a growing consensus that rates will have to rise across the world to counter inflationary pressures.
At its latest scheduled meeting, the US central bank's policy-making Federal Open Market Committee left its target for overnight federal funds rate at 1 per cent the lowest level in 45 years where it has stood since last June.
But in an accompanying statement, the FOMC indicated that the risk of deflation, that had kept rates so low, had now virtually disappeared. Inflation was not a threat either for the time being, but the stronger economy meant that "existing policy accommodation can be removed at a pace that is likely to be measured," the Fed said in typically convoluted style.
The decision had been keenly awaited in the wake of repeated hints that the Fed was limbering up to change its stance on monetary policy.
Last week, the International Monetary Fund revised its global growth forecasts up sharply and warned that interest rates must rise in "almost all countries". It specifically urged central banks to communicate their intentions to the markets as clearly as possible to avoid delivering a sudden shock particularly to countries such as the US and Britain with high levels of public and private debt. The Fed's message to the markets last night was clear: rates will be rising, but in a gradual fashion. "This means an increase is coming relatively soon, sooner rather than later," Alan Blinder, a former Fed vice-chairman, said. "They've got to go a lot past 2 per cent, maybe to 4 per cent. But of course there's an election on the way."
The Dow, down by 35 points before the central bank announcement, briefly rallied to show a 72-point gain before ending almost flat at 10,317.2. In fact, key interest rate futures have already priced in an increase of at least 0.25 per cent, or 25 basis points, by summer, while Alan Greenspan, the Fed chairman, has been assiduously preparing the ground for such a move in recent weeks.
Not only is the economy gaining steam but there are signs inflation is on the rise. The Commerce Department's price deflator, a commonly used measure of inflation, climbed at an annual 2.5 per cent rate in the first quarter of 2004, up from 1.5 per cent in the previous quarter.
The economy created more than 300,000 new jobs in March, suggesting that the "jobless recovery" which has bedevilled President Bush's re-election hopes may at last be ending.
Although Australia is the next bank to set rates, the real focus now shifts to tomorrow when the Bank of England and the European Central Bank both set rates against a contradictory economic background. The Bank of England, under its governor Mervyn King, was one of the first banks to start tightening policy when it ordered a rate rise last November. With the British economy firing on all cylinders, its monetary policy committee is expected to raise rates tomorrow. In contrast, the ECB president Jean-Claude Trichet is under growing pressure from France and Germany to cut its main rate in the face of anaemic economic recovery.Reuse content