Federal Reserve raises rates by quarter of a point

The Federal Reserve has raised its short-term interest rate by a quarter of a percentage point to 5 per cent. However, the move encouraged investors as the Fed gave no indication that a further increase may be needed later this year to cool down the heated US economy. The Dow Jones industrials index on Wall Street, which had been down 50 points since opening, surged over 100 points when the announcement was made by the Federal Open Market Committee, headed by Fed chairman, Mr Alan Greenspan. It later closed up 155.49 at 10,970.80, .

Treasury bonds, which had been falling, also rose on hearing the news, driving down the yield on the 30-year bond.

The announcement came at the end of a two-day meeting in Washington of the Fed's 12-member policy-making Open Market Committee.

In its statement, the FOMC said: "Much of the financial strain has eased, foreign economies have firmed and economic activity in the United States has moved forward at a brisk pace."

The committee surprised the markets by saying that a so-called bias towards higher interest rates has now been dropped, providing the indication that no further rise is in prospect in the short term.

"Owing to the uncertain resolution of the balance of conflicting forces in the economy going forward, the FOMC has chosen to adopt a directive that includes no predilection about near-term policy action," the statement said.

There was also a strongly-positive reaction in the Chicago stock exchange. Investors were especially heartened at the news that the Fed has moved from the so-called "tightening bias" of last month, when it clearly indicated that it was preparing to raise interest rates.

Yesterday's announcement is regarded as a "neutral bias" because it gave no clues as to the Federal Reserve's intentions on interest rates later this year.

It has been the first change in the overnight inter-bank lending rate since November 1998, when the Federal Reserve made the third of its reductions in the rate to reassure markets after the Russian debt default and the drop in Wall Street last August.

The minimum increase in the lending rate had been largely anticipated. While it will translate into a small increase in credit card and mortgage interest rates, this is not expected to affect the consumer boom which has the US economy roaring ahead for one of the longest uninterrupted expansions in its history.

However, the chief economist at Morgan Stanley Dean Witter, Mr William Sullivan, in New York warned that the "neutral bias" in the Fed's statement did not mean there could not be a further interest rate rise this year. "They are still capable of raising rates later in the year if we don't get a cooling in economic growth," Mr Sullivan said.

The Federal Reserve lowered interest rates three times late last year by a total of 0.75 percentage points to "counter a significant seizing up of financial markets" instigated by the global financial crisis.

The US consumer price index was flat in May and overall inflation is currently tame.

The rate increase had been widely anticipated in financial circles, notably as Mr Greenspan, in congressional testimony on June 17th, spoke of inflationary pressures in the economy that called for modest pre-emptive action by the US central bank.

He has warned that consumers were spending money faster than they were boosting income, employers were having trouble finding workers and productivity - despite impressive gains - was not increasing rapidly enough.