US markets surge as Fed raises rates as expected

The US stock market surged yesterday after the Federal Reserve, as expected, raised interest rates for the 17th time in two years. The 0.25 per cent increase brings US interest rates to 5.25 per cent and many analysts expect a further rise in August.

A Fed statement said that US economic growth has moderated, but that "some inflation risks remain" and that it would take both factors into account in future interest rate decisions. The statement was moderate enough to calm nerves among some traders who feared that the new Fed chairman, Ben Bernanke, might raise rates so high that the US economy would suffer.

"Economic growth is moderating from its quite-strong pace earlier this year, partly reflecting a gradual cooling of the housing market," the statement said, noting that earlier interest rate hikes and rising energy prices were dampening growth.

The Federal Reserve's open market committee said its decision to raise interest rates was unanimous and introduced some doubt about future increases.

"The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information," the committee wrote.

The new language replaced previous wording that said "some further policy firming may yet be needed".

Mr Bernanke has said repeatedly that the US economy is "transitioning" to a period of lower growth and price and retail-sales figures released early this month showed evidence of a slowing economy.

Mr Bernanke confused markets and drew criticism in recent weeks by making apparently inconsistent comments on his view about how rising energy prices and slower growth have affected the economy.

Markets soared when he hinted to congress on April 27th that he might hold off on further rate increases, but he has subsequently sounded more aggressive about holding down inflation by raising interest rates.

In a speech in Chicago two weeks ago, he suggested that inflationary pressures weren't out of control but warned that energy prices had to be watched carefully.

"The cumulative increases in energy and commodity prices have been large enough that they could account for some of the recent pick-up in core inflation," he said.

Critics complain that, despite his immense experience as an economist and a central banker, Mr Bernanke has appeared insensitive to the weight each of his remarks carries in the markets.

Most analysts predict that US interest rates could reach about 6 per cent early next year but that any increase beyond that could plunge the world's biggest economy into recession. Meanwhile US treasury debt prices rallied after the Federal Reserve raised interest rates as expected.

Rick Egelton, chief economist at BMO Financial Group, said the statement by the open market committee suggested "that we may not be at the end of the tightening cycle but we're pretty close to it".

"The bond market's reaction was predictable given that the market was anticipating something a little more hawkish from the Fed," he said.