labels: economy - general
US Fed maintains course; less hawkish on inflation news
30 June 2006

Mumbai: As expected, the The Federal Open Market Committee, the Federal Reserve's policy-setting arm, raised short-term interest rates by 25 basis points for the 17th straight time to 5.25 per cent per annum yesterday in the current tightening cycle. The Fed rates are now at their highest since the first quarter of calendar 2001.

The Fed said that further increases depend on future information about the prospects for growth and inflation. The Fed started hiking rates in mid-2004 and this is the longest period of rate hikes in the US central bank's history.

"The committee judges that some inflation risks remain,'' the Federal Open Market Committee said in a statement after a two-day meeting in Washington. "The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.''

Financial markets were excited, as the Fed was less hawkish on inflation in the statement, which announced the decision. Recent inflation levels have been "elevated", but "inflation expectations remain contained" as "ongoing productivity gains have held down the rise in unit labour costs".

The statement shows that the Fed is concerned about the slow down in the US economy. "Recent indicators suggest that economic growth is moderating from its quite strong pace earlier this year, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices," the statement said.

Some economists and analysts are interpreting these statements as pointers to a likely pause to rate hikes after one more 25 basis point increase in August. Stock markets cheered the statement and the Dow Jones index surged 2 per cent and NASDAQ closed 3 per cent higher.

But the Fed is still not committing itself to a pause and is clearly keeping its options open. The statement adds, "some inflation pressures remain", though 'moderation in the growth of aggregate demand should help to limit inflation pressures over time'.

While there was a certain amount of speculation that the Fed could surprise the market with a 50 basis point increase, it however stuck to its tradition of gradualism. The post meeting statement by the committee has been interpreted by investors as suggesting that the central bank may well be contemplating a breather after having nudged rates higher at every meeting for the past two years.

This cycle of rate increases is the Fed's longest since the 1970s, beginning in June 2004 when the rate was 1 per cent.

By way of immediate response, the dollar fell to its lowest in four weeks against the yen and Treasury notes jumped. Stocks registered early gains with traders factoring in the possibility that the Fed might not lift rates again in August, when it next meets to take stock of the situation.

At least sixteen central banks around the world have pushed borrowing costs higher this month. The Fed's latest move keeps its rate the highest among the Group of Seven industrialized countries.

Fed officials are trying hard to avoid a hard landing for the economy where high interest rates may curtail job growth and consumer spending. According to the Mortgage Bankers Association, the average rate on a 30-year fixed mortgage jumped to 6.86 per cent last week, the highest in more than four years.

also see : Tough choices for Ben Bernanke

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US Fed maintains course; less hawkish on inflation