Fed raises US interest rates to 1.5% as recovery stays on track

The Federal Reserve has raised US interest rates by a quarter of a percentage point to 1.5 per cent, indicating that the US economic recovery remains well on track.

The US monetary authority seemed to hint, however, that further rate hikes could depend on the stability of oil prices.

The explicit mention of energy prices by the Federal Open Market Committee (FOMC) in its monthly statement yesterday is likely to see international markets focus increasingly on oil over coming weeks.

Oil hit records above $45 a barrel yesterday before news of restored Iraqi supplies sent prices back down towards $44 a barrel.

The FOMC yesterday said that US economic growth had "moderated" over the past few months, adding that the "pace of improvement in labour market conditions has slowed".

This latter statement acknowledges last Friday's surprisingly low figures on job creation in the US, with employers adding just 32,000 new positions. This compared to consensus forecasts of 230,000.

"This softness likely owes importantly to the substantial rise in energy prices.The economy nevertheless appears poised to resume a stronger pace of expansion," the FOMC said.

Mr Niall Dunne, financial markets economist with Ulster Bank, last night expressed some surprise at the direct link made between oil and economic output. "This will make oil the key barometer for equity, bond and currency markets for the next 18 months," he said.

Mr Dunne believes the FOMC is allowing itself the option of holding off on further rate hikes if oil prices post further notable increases over coming months.

The Committee is due to have three more meetings before the end of the year - in September, November and December. It had been expected to add a further half a percentage point to rates before the end of the year.

Following last Friday's poor US jobs numbers however, futures contracts had set the probability of a Fed rate increase at the September meeting at less than 50 per cent.

Yesterday's move was widely anticipated after the Fed raised rates last month for the first time in more than three years.

The tone of the FOMC's latest statement was broadly in line with the testimony of Mr Alan Greenspan, Fed chairman, before the US Congress last month.

The committee reiterated its belief that, with underlying inflation low, rates could be moved back towards a more neutral level "at a pace likely to be measured".

Mr Dunne said rates are simply too low in the US at the moment, with an increase to 2 per cent more than necessary in the near term.

He said the reference to oil in the FOMC's statement indicated Fed was currently "sitting on the fence a little bit", adding that the committee would have lost credibility if it had not moved yesterday.

Mr Dunne is expecting the European Central Bank to follow the Fed with an interest-rate hike at some point over the coming nine months.

He suggested that further increases in oil prices - above $50 a barrel for example - could actually precipitate a rate increase in the euro zone, where policymakers are concerned solely with inflation.

Markets are expecting euro-zone rates to rise from 2 per cent to 2.5 per cent before this time next year.

US stocks made strong gains in afternoon trade yesterday after Wall Street shrugged off the quarter-point interest rate hike and took reassurance from the Fed's positive comments on the economy.

The dollar also firmed on the news, with the euro falling to about $1.2259, down from around $1.2305 shortly before the Fed announcement and down about 0.1 per cent on the day.

US foreign exchange analysts said the "real line" in the Fed's post-meeting statement was that the economy was poised to resume a stronger pace of expansion going forward.

"The Fed still sees our current condition as transitory regardless of the recent slowdown and they are hinting there will be more rate hikes going forward," said Ms Kathy Lien, chief strategist with Forex Capital Markets in New York.