The move sent US bonds surging, with the bell-wether 30-year US Treasury bond trading up almost a full point. The action had been widely expected and the market had largely discounted the increase, but the Fed's chairman, Alan Greenspan, again surprised the market by the timing of the announcement.
Instead of signalling its new target through intervention in the market shortly before noon, as usual, the Fed instead announced the move in a brief statement at the end of a meeting of its Federal Open Market Committee.
Mr Greenspan said the Fed had decided 'to increase slightly the degree of pressure on reserve positions . . . This action is expected to be associated with a small increase in short-term money market interest rates.'
While the Fed cited no target figure, economists agreed that the 'small increase' almost certainly referred to another quarter-point rise in the overnight bank lending rate, the second in two months. Some traders had predicted a more drastic move to slow the US expansion, including a half-point rise in the discount rate.
If the rise in US rates is received badly by world bond markets today, it could make it more difficult for the Chancellor, Kenneth Clarke, to cut rates again in Britain. Mr Clarke is thought likely to want another cut to offset the impact of next month's tax increases and to help Conservative fortunes in the local and European elections.
Roger Bootle, chief economist at Midland Bank, said the American move should already have been priced in, but that the world bond and equity markets would none the less probably react adversely. But he added that the move was unlikely to have any impact on British interest rates, with prospects crucially determined by today's inflation figure for February, which he expects to show a sharp drop.
At its usual intervention time, the Fed instead executed two-day system repurchase agreements, leading many traders to believe the committee had decided against an increase in rates. Despite the release of new trade figures yesterday, suggesting a slowing of economic growth in the US, investors have grown increasingly concerned about the prospect of inflation.
Some expressed anger when the Fed failed to act earlier in the day, suggesting that the central bank had succumbed to political pressures from the White House. Mr Greenspan unexpectedly met President Bill Clinton last Friday, and although they said rates were not discussed, many interpreted the discussion as an attempt to influence yesterday's meeting.
The US reaction to yesterday's move was in sharp contrast to that which followed the 4 February announcement on a reversal in the interest rate change, raising hopes that world markets would take the move well. The bond market plummeted that day, and the Dow Jones average dropped almost 100 points. Yesterday the Dow Jones average fell only slightly after the news to close down by 2.30 points.
The financial markets were transfixed by the FOMC meeting during London trading hours. The FT-SE index of 100 leading shares closed 3.5 points higher at 3,201.5, with the Fed's neutral noon intervention in the money market coming just after the market closed.Reuse content