Fed raises interest rates by 0.25%

Irish borrowers should prepare for interest rate rises of up to 1.5 per cent over the next 18 months, leading economists said following last night's news that US rates have increased for the first time in nearly three years.

The US Federal Reserve last night announced that it was raising interest rates by 0.25 per cent to 1.25 per cent. The move was widely expected and prompted little reaction from the markets.

Irish economists said the increase marked the end of a period of historically low borrowing costs.

"This era of cheap money is at an end, and this marks the beginning of the tightening in the interest rate cycle," Bank of Ireland chief economist Dr Dan McLaughlin said.

Both he and Mr Jim Power, chief economist with Friends First, agreed that while European and Irish rates would not follow suit immediately, it was inevitable that rates in Europe would follow the US trend.

"The European Central Bank \ will eventually do likewise, but it is under no immediate pressure because European growth is still pretty modest, inflation is subdued and European unemployment is quite high," said Mr Power.

He said it would be very late this year or early in 2005 before the ECB was likely to increase its key repo rate, which has been at 2 per cent for the last year. This in turn would spark an increase in interest rates here.

"Irish borrowers need to be aware that probably over the next 18 to 24 months, European rates are likely to rise by up to 1.5 per cent," he said. "They need to factor that in now."

Dr McLaughlin said he doubted if there would be a rate rise in Europe before the end of the year. "I would think it reasonable that we will see interest rates rise by 1.5 per cent over the next 18 months," he added.

He added that the ECB was anxious to allow key European economies such as Germany and Italy to gain momentum. Growth in the large central EU economies has been slower than expected so far this year.

The Fed's announcement met a muted response in the US last night. Markets there had already factored in the widely expected 25 basis points increase.

Immediately after the announcement, mid-afternoon New York time, the dollar fell against the euro.

The euro stood at $1.2175 before the announcement and jumped to $1.2199 immediately after it.

In its statement, the Fed's policy-making body, the Federal Open Market Committee (FOMC), said it would "provide ongoing support to economic activity".

Economists interpreted this as indicating that it would take a gradual approach to increasing rates for the rest of the year.

The statement said that US inflation during the first half of the year had been "somewhat elevated", but it added that at least some of the factors that caused this were transitory.

Mr Power said that this was a reference to the increased oil prices, largely a consequence of the war in Iraq.

The FOMC added that the "upside and downside risks to sustainable growth and price stability for the next few quarters were roughly equal", indicating that the committee does not believe that there is any factor at work that could put upward pressure on inflation.

However, it added the rider that it would respond to change in economic prospects as needed in order to meet its obligation to maintain price stability, which economists took as a warning that the Fed would take more drastic action than a 25 basis points rise if it believed this was necessary.

Fed chairman Mr Alan Greenspan is expected to elaborate on Fed policy to Congress when he testifies there this month.