The US Federal Reserve has raised interest rates by a quarter of a percentage point but has also signalled that this could be the last increase this year as it seeks to damp down inflationary trends.
The federal funds rate, which banks charge each other on overnight loans, has been increased to 5.25 per cent, the second such increase in eight weeks. The increase was widely expected by the markets and expectations that it would be the last such increase for some time had helped push the Dow Jones industrial average up to a record 11,299 on Monday.
Yesterday after the increase was announced, the Dow Jones average of 30 blue-chip stocks immediately rose again but later gave ground to close at 11,283.3, down 16.46 points on the session.
More surprising was the decision by the Fed also to increase the lesser-used discount rate by a quarter of a point to 4.75 per cent. This is the first increase in this rate since February 1995.
In a statement accompanying the increase in interest rates, the Fed said that its actions yesterday and the quarter point increase of last June 30th should "markedly diminish the risk of rising inflation going forward".
This is interpreted as a "neutral" bias which gives no indication that a further increase is to be expected this year. Some dealers had expected the Fed to switch from a neutral bias to a readiness to tighten and thus clamp down firmly on any threat of inflation later this year.
The economy is expected to grow at 4 per cent this year and unemployment, now at a record low, could fall further. The increased pressure on the labour market could, however, push up wage costs and lead to the inflation that the Fed is so anxious to avoid. The Fed's next policy session is on October 5th.
Last year the Fed decreased interest rates three times to restore confidence following the currency crisis in Russia and the turmoil in the Asian economies.
The Fed statement yesterday said: "With financial markets functioning more normally and with persistent strength in domestic demand, foreign economies firming and labour markets remaining very tight, the degree of monetary ease required to address the global financial market turmoil of last autumn is no longer consistent with sustained, non-inflationary economic expansion."
Last July, following the quarter percentage point increase to 5 per cent the Federal Reserve chairman, Mr Alan Greenspan, told Congress that the Fed would move "promptly and forcefully" to counter inflation. This was taken to mean a rate increase at the August meeting of the Federal Open Market Committee and this has now come to pass. Demand has grown at an average annual rate of more than 3.5 per cent for the last three years, but in the last month, Mr Greenspan has warned that continued rapid growth would prompt a restraining move by the central bank.
