Bullish Fed raises rates after 'robust' productivity growth

The Federal Reserve raised its key short-term interest rate by 25 basis points yesterday. It also hinted it would continue to nudge rates gradually higher in the months ahead, as the economy continued to strengthen.

The Federal Reserve raised its key short-term interest rate by 25 basis points yesterday. It also hinted it would continue to nudge rates gradually higher in the months ahead, as the economy continued to strengthen.

The increase, the third in a row by the policy-making Federal Open Market Committee, had been widely predicted. It boosts the benchmark federal funds rate to 1.75 per cent, compared with the 45-year low of 1 per cent where it stood for a year until June 2004.

In a notably bullish accompanying statement, the FOMC spoke of a "robust underlying growth in productivity". It noted too that "economic growth appeared to have regained traction", indicating the Fed's belief that the recovery was back on track after its brief wobble in late spring. In a keenly watched paragraph on the future prospects for the economy, the central bank indicated that the upward and downward risks for growth and inflation were "roughly equal".

With underlying inflation expected to be relatively low, the committee believes that policy accommodation can be adjusted "at a pace that is likely to be measured". But it kept its options open, indicating it would respond "as needed" to changes in the overall outlook.

The FOMC meeting was its last before the 2 November election. But barring major unexpected developments, economists expect at least one further 25-point increase in the fed funds rate at its meeting in November or December. This would bring the central bank close to the sought-after "neutral" monetary policy stance - implying an interest rate of 3 or 3.5 per cent, analysts believe.

The Fed's optimism is reflected in the latest statistics here. August saw the creation of 144,000 new jobs, while housing starts registered an unexpected 0.6 per cent gain last month, according to figures from the Commerce Department.

Nonetheless, the Organisation for Economic Co-operation and Development cut its forecast for US growth from 4.7 to 4.3 per cent yesterday, blaming the lacklustre job market. "With policy stimulus and supportive wealth effects fading, the US expansion increasingly hinges on employment creation and business investment," Jean-Philippe Cotis, the OECD chief economist, said.

Overall growth for the group of six richest countries was revised up to 3.6 from 3.4 per cent. The Paris-based organisation raised its forecasts for UK growth from 3.1 to 3.4 per cent, close to the top of the Chancellor's forecast of 3.0 to 3.5 per cent that he published two years ago.

It puts the OECD in line with economists in the City of London, who also expect 3.4 per cent, and just behind the International Monetary Fund on 3.5 per cent. It praised the Bank of England for "being proactive" in raising rates to head off the threat of a jump in inflation.