US eases up interest rates

The Federal Reserve sought to take the froth off the booming American economy yesterday when it nudged up interest rates for the first time in two-and-a-half years - but hinted that there was no need yet for a bigger squeeze.

In one of the most widely anticipated moves in recent years, Alan Greenspan, the Fed chairman, delighted Wall Street by signalling that he would have to see signs of inflation before last night's quarter-point rise in borrowing costs was followed with further monetary tightening.

The Dow Jones Industrial Index, which had been down 30 points ahead of the central bank's announcement to move overnight lending rates up to 5%, was up by more than 150 points within 15 minutes of the decision. Broader measures of the stock market, including the interest-rate sensitive technology sector were also sharply higher.

Markets had been on alert for the rise since the Fed announced that it had moved its stance towards raising rates. However, fears that it would rescind the three cuts in borrowing costs last Autumn were dispelled when the central bank said it now had no bias in either direction.

The yield on the benchmark 30-year US Treasury also fell on signs that the increase from 4.75% to 5% could be the last for several months. The benchmark bond had been yielding more than 6% before the an nouncement, close to 19-month highs.

Ian Shepherdson, of High Frequency Economics, called the decision to lift rates by 25 basis points a "cheap insurance policy" to prevent the US economy overheating. "Greenspan is a true incrementalist," he said. "Faced with last year's global meltdown he only cut rates by 25 basis points [at a time]." However, Mr Shepherdson warned the market not to assume there would not be further rate rises.

Amid signs that the Fed's Open Market committee may have struck a compromise, the statement released after the decision said that the air of crisis that marked the aftermath of Russia's debt default and the collapse of the Long-Term Capital Management hedge fund had melted away and there was no longer a need for the cheaper borrowing costs introduced last autumn.

However, the Fed stressed that there was little real evidence of the American econ omy overheating. "Much of the financial strain has eased, foreign economies have firmed, and economic activity in the US has moved forward at a brisk pace," said the statement, announcing the first rise in the overnight bank lending rate since March 1997. "Owing to the uncertain resolution of the balance of conflicting forces in the economy going forward, the federal open market committee has chosen to adopt a directive that includes no predilection about near-term policy action," the Fed said.

The Fed has been worried that continuing low employment levels will push up wage demands. However, unemployment levels of 4.2%, the lowest since the early 1970s, have had a relatively benign effect on wage inflation.

Other indicators of economic activity have been mixed, with high oil prices largely failing to show through in much lower levels of consumer spending.