US set for rates rise to head off inflation

THE US Federal Reserve is this week expected to raise interest rates, marking a watershed in US economic policy and reversing the downward trend of the last four years.

The Fed's Open Market Committee meets on Tuesday and Wednesday, and is expected to increase rates by a quarter of a point to head off any signs of resurgent US inflation.

Financial markets are primed and ready, and the decision - when it comes - may actually spark buying. The Fed has been signalling since last December that it was shifting away from further cuts, and it confirmed at its last meeting that it had shifted towards a bias in favour of an increase.

Alan Greenspan, the Fed Chairman, in testimony to Congress on 17 July, said that "When we can be pre-emptive we should be," a clear hint that a move was on the way.

It is possible that the Fed could raise rates by more than a quarter of a point this week, but it normally prefers to move in smaller steps. And there is little indication at the moment that it needs to move faster. The economy still shows few signs of inflation, if any.

The latest figures at the end of last week again painted a picture of a resilient economy that is neither slowing nor spinning off into a wage- price spiral. GDP growth for the fourth quarter was revised up from 4.1 per cent to 4.3 per cent, the difference explained by an improving export picture: some of the once-depressed markets abroad are starting to recover. Corporate profits were at their healthiest for four years. The GDP deflator, one measure of inflation, was rising at an annual rate of 1.6 per cent, slightly higher than originally estimated but still very low.

This would be the first rate rise since March 1997, but that increase - which followed two years of cuts, from 6 per cent in February 1995 - was a blip.

In effect, the Fed has been loosening policy for four years; before that, it had raised them for two-and-a-half years, from September 1992 to February 1995. Mr Greenspan has hinted that he wants to reverse the last three rate cuts from last year, which were a response to concerns about liquidity and international markets following the crisis in Asia, Latin America and Russia last year.