Third Fed rate rise as US picks up

The US Federal Reserve last night raised interest rates for the third time this year in spite of a renewed surge in oil prices.

The widely expected move took the Fed funds' rate up a quarter-point to 1.75%, following similar moves in August and June.

The Fed had cut rates last year to a 46-year low of just 1% in an attempt to boost an economy suffering the aftermath of the bursting of the dotcom bubble and the war in Iraq which had dented consumer confidence.

This was the last Fed meeting ahead of the November 2 presidential election but is thought unlikely to damage George Bush's chances of re-election, especially as interest rates remain low in historical terms and the economy appears to be recovering from its summer "soft patch", as Fed chairman Alan Greenspan described it.

The federal open market committee, in a statement accompanying its decision, repeated Mr Greenspan's statement earlier this month that the US economy had "regained some traction" and that interest rates were still low and therefore boosting the economy. It repeated its usual statement that it would continue to raise interest rates at a "measured pace". It also said its vote for higher rates had been unanimous.

Economists were not surprised. "Greenspan, along with many of his FOMC colleagues, obviously feels that with rates still so low, the Fed should not be swayed by short-term economic fluctuations from its policy of returning rates to more appropriate levels at a measured pace," said Paul Ashworth of consultants Capital Economics.

The danger to the US economy from rising oil prices was accentuated yesterday as US light crude futures rose nearly $1 a barrel to $47.30, driven by strong Chinese demand, fears over exports from Russian oil group Yukos and damage to offshore US oil rigs from Hurricane Ivan.

Greenspan had previously blamed rising oil prices, up 40% this year on strong global demand and tight supply, for the summer slowdown in the US economy.

A month ago US light crude set an all-time high of $49.40 a barrel before dropping back towards $40 a barrel. That fall has proved short-lived and oil prices have headed higher again.

There was some good news from the US economy, yesterday as the number of new houses being built unexpectedly rose 0.6% to a five-month high of 2m on an annualised basis. Economists said this showed the housing market appeared to be robust in spite of the Fed's rate rises.

Economists are divided as to how far and how fast the Fed will raise interest rates. Most see the Fed rate up to 2% by the end of the year and 3% or higher by the end of 2005, depending on the economy, with the big question being consumer spending.

"Consumers continue to suffer under the combined weight of high oil prices, rising interest rates, the fading of the boost from past tax cuts and a faltering labour market," said Mr Ashworth.

Merrill Lynch economists predict that the Fed will raise rates to 2% on November 10 and then stop.

"Our big-picture analysis is that we think the economic soft patch is turning out to be more than just a patch and that the economy is more vulnerable than the Fed had perceived," said Merrill's Kathleen Bostjancic.