US puts up interest rates

The US central bank increased the cost of borrowing for the fifth time in nine months yesterday in an attempt to slow down the record-breaking US economy.

Yesterday's decision by the Federal Reserve Bank to lift the benchmark Fed Funds rate by 25 basis points to 6 per cent brings the cost of borrowing to its highest level for five years.

Announcing the decision, the bank suggested that it could continue to increase rates because it fears higher inflation. Alan Greenspan, the Fed chairman, said that with economic conditions showing no signs of slowing down he was still concerned that demand was outstripping supply.

The Fed also decided unanimously to increase the discount rate by 25 basis points to 5.5 per cent, which several analysts took as a sign of greater-than-expected concern among its board members.

Investors had expected a further increase in the main overnight bank lending rate, however, and the markets showed little immediate reaction to the news yesterday.

The Fed was expected to increase rates because of continuing signs of growth in the US economy. Official figures released just before yesterday's announcement revealed a sharp increase in the US trade deficit to a record $28bn in January.

This 14 per cent increase, well above expectations, reflected stronger demand for imports and higher oil prices in the period.

The Fed is likely to have taken such signs of increased spending by US consumers in spite of higher oil prices as a reminder of inflationary risks.

High Frequency, an economic research group, said that the deficit implied further increases in gross domestic product to around 7.8 per cent from just under 7 in the last quarter.

Such forecasts explain why many analysts expect at least one more rate increase before the end of the year. Several expect as many as three more if the economy continues to show little sign of slowing down.

Few believe the Fed will raise rates by more than 25 basis points at a time, however. Ian Shepherdson at High Frequency echoed others in pointing out the lack of political support for larger increases during an election year.

The Dow continued to trade up more than 100 points, or about 1 per cent, after the announcement. The market had been buoyed by a positive court ruling for tobacco companies and strong earnings results from financial services companies earlier in the day.

Fears over further rate increases had already helped push the Nasdaq down more than 10 per cent from its March high in recent days, however.