Fed turns tide on US interest rates

America's central bank, the Federal Reserve, served notice last night that rock-bottom interest rates in the world's biggest economy were a thing of the past when it raised the cost of borrowing for the first time in four years.

In a unanimous decision, the Fed's open market committee pushed up its federal funds rate by a quarter point to 1.25% and hinted that it would adopt a measured approach to any future increases.

The widely anticipated move followed a year in which the fed funds rate had been left at a 40-year-low of 1% in order to guarantee that the US economy would enjoy a sustained recovery from the slowdown that followed the collapse of the dotcom bubble and the terrorist attacks on September 11 2001.

Despite the political sensitivity of tighter monetary policy with a presidential election looming, the Fed, led by chairman Alan Greenspan, acted in response to evidence that economic growth was at last starting to lead to more jobs, and made it clear that further rate increases were in the pipeline.

The central bank announced that even after last night's modest move, interest rates were still at a low enough level to stimulate the economy. "The evidence accumulated [since the open market committee last met] indicates that output is continuing to expand at a solid pace and labour market conditions have improved," it said.

With oil prices lower than they were at their peak in May, the Fed shrugged off signs of mounting inflationary pressure. The data were "somewhat elevated" but part of the increase was due to "transitory factors".

It added that the open market committee believed "the upside and downside risks to the attainment of both sus tainable growth and price stability for the next few quarters are roughly equal. With underlying inflation still expected to be relatively low, the committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the committee will respond to changes in economic prospects as needed to fulfil its obligation to maintain price stability."

Wall Street had been braced for a quarter-point increase and was more interested in the statement accompanying the move. In the aftermath of the announcement, there was virtually no change in either the Dow Jones average of blue-chip stocks or the technology-rich Nasdaq index.

Kurt Karl, head of economic research at Swiss Re in New York, said: "This is very much as expected. The reference to inflation data being 'somewhat elevated' is something that Greenspan and other Federal Reserve officials have said repeatedly. They don't view the current rapid rise in inflation as going up and up and up. They believe things will alleviate themselves with time. Nevertheless, they need to start getting away from a very accommodative stance.

"They are taking a measured pace and will get substantially above inflation and slow down economic activity."

Kevin Logan, senior economist at Dresdner Kleinwort Wasserstein in New York, said: "The Fed did exactly what they wanted to do, which was not to move the markets today. They telegraphed this move well in advance.

"They do intend to raise the funds rate at a measured pace, which I infer to mean 25 basis points per meeting, taking the federal funds rate to 2.0% at the end of the year and then they'll pause. The Fed doesn't believe the recent increase in inflation is permanent."