Fed signals no change in interest rates

Corporate cost-cutting pushed up US productivity at the fastest rate in nearly 20 years in the first quarter, reducing pressure on the Federal Reserve to raise interest rates.

Non-farm productivity rose at a seasonally adjusted annualised rate of 8.6 per cent, the US Labor Department said.

The Federal Reserve yesterday left interest rates on hold at 1.75 per cent, as widely expected, and signalled no change in the neutral bias towards the future direction of interest rates.

The statement released with the decision was almost identical to that published at the previous meeting in March, saying that the risks around both inflation and growth were balanced "for the foreseeable future".

The increase in productivity was the biggest gain since the second quarter of 1983 and followed a strong 5.5 per cent rise in the fourth quarter of last year. The productivity surge helped to restrain inflationary pressure, reducing unit labour costs by 5.4 per cent in the first quarter.

Mr Maury Harris, US economist at the investment bank UBS Warburg, said that continued productivity growth would help solve the Fed's problem of wanting to support the economic recovery while worrying about inflationary pressures.

"The continued strong pace of productivity growth means that the US economy can grow quite briskly without lowering the unemployment rate or triggering Fed tightening," he said.

The decision to leave rates unchanged was almost unanimously expected by independent economists. Signs that the economic recovery was continuing, such as the 5.8 per cent annualised growth in the first quarter, have been tempered by weakness in equity prices and the dollar.

A large majority of independent economists believes that the Fed will not begin to raise interest rates until at least August.

The Federal Reserve has been balancing the need to reassure companies and investors that monetary policy will stay loose enough to support growth and the desire at some point to return interest rates to more normal levels.

In recent weeks, financial markets have been concerned about the US's large current account deficit and the possibility of a sharp fall in the currency.

In congressional testimony last month, Mr Alan Greenspan, Federal Reserve chairman, said that while signs of a recovery were encouraging, "the dimensions of the pick-up are still not clear".

"The degree of strengthening in final demand over coming quarters . . . is still uncertain," he said. He also warned that, while the US economy's productivity performance should remain strong, the recent very high rates of growth might moderate in the future. "The world just doesn't work that well," he said.

Economists had expected an increase of around 7 per cent in productivity growth before yesterday's figures were released. Expectations of continued rapid productivity growth are critical for validating the high valuations still placed on US equities despite recent falls.

The persistent slump in investment in labour-saving technologies has raised doubts about how long the productivity surge will last. But Mr Harris at UBS Warburg said previous surges in technological development would support continued strong gains.