Fed raises interest rates to fight inflationary trends

The Federal Reserve, the US central bank, has raised US interest rates for the third time in five months in a bid to restrain the frantic pace of economic growth and keep the lid on inflationary pressures.

The Fed's policy-making open market committee raised its primary interest rate instrument, its target for the federal funds rate, by 0.25 percentage points to 5.5 per cent, and also nudged up the discount rate by the same amount to 5 per cent.

The move took US short-term rates back to where they were a little over a year ago, before the central bank cut them aggressively to shield the US economy from the fallout from the global financial crisis.

"Today's increase in the federal funds rate, together with the policy actions in June and August and the firming of conditions more generally in US financial markets over the course of the year, should markedly diminish the risk of inflation going forward," the Fed said in a statement.

But the Fed also shifted its so-called "bias", an indication as to which way the central bank is leaning, back to neutral, from a bias towards tightening adopted at its meeting last month.

"Although cost pressures appear generally contained, risks to sustainable growth persist," the Fed said. "Despite tentative evidence of a slowing in certain interest-sensitive sectors of the economy and of accelerating productivity, the expansion of activity continues in excess of the economy's growth potential."

Wall Street reacted positively to the Fed change in bias, with the Dow Jones Industrial Average gaining 171.88 points (1.60 per cent) on the day to end at 10,932.63.

But analysts cautioned that the committee statement contained worrisome references to what has become a virtual preoccupation for Federal Reserve chairman Mr Alan Greenspan: the steady contraction in the pool of available workers.

That pool, according to First Union chief capital markets economist David Orr, shrank 246,000 or 2.5 per cent in October and now numbers 9.8 million people compared with 15.6 million five years ago.

Counted in the pool are the unemployed, those seeking work and those not actively looking but who have told government survey-takers they would accept employment.

With activity increasing faster than the economy's non-inflationary growth capacity, according to the committee, "the pool of available workers willing to take jobs has been drawn down further in recent months, a trend that must be contained if inflationary imbalances are to remain in check and economic expansion continue."

In other words, said Mr Orr, "either this pool stops going down or the fed funds rate keeps going up."

The US economy continues to expand at rates well in excess of what the Fed's economists have historically considered consistent with stable inflation. In the three months to September, gross domes tic product grew at an annual rate of 4.8 per cent, and when the final figures are in for 1999 they are likely to show a fourth straight year of growth of about 4 per cent.

Even though Mr Greenspan accepts that the economy's long-term potential has improved, yesterday's decision reaffirms the Fed's belief that growth still needs to slow to avoid even the risk of inflation picking up.

In another sign of the continuing rapid pace of growth, the Fed also reported yesterday that industrial production rose by a seasonally adjusted 0.7 per cent in October from a month earlier.