The Federal Reserve Hikes Up Rates - End in Rate Rises in Sight

Submitted by Share Trading on 14 December, 2005 - 09:49

The US Federal Reserve overnight lifted US borrowing costs for the 13th time running but signalled a possible end to its campaign of rate hikes as chairman Alan Greenspan prepares to retire.

As expected, the US central bank raised the benchmark interest rate paid by banks on overnight loans by a quarter point to 4.25 percent. The rate steers lending costs throughout the world's biggest economy.

But a brief statement accompanying the Fed announcement contained major changes of language, which were seized upon by the markets to signal US interest rates may soon take a breather from their upward trajectory.

On the one hand, the rate-setting Federal Open Market Committee (FOMC) said "that some further measured policy firming is likely to be needed" to keep economic growth and stable inflation in balance.

That would indicate that at least one more rate hike is in the works before Greenspan retires at the end of January and hands over the reins to his heir apparent, top White House economic adviser Ben Bernanke.

But Greenspan and his colleagues deleted the term "policy accommodation" from their statement, which they had used to fuel expectations of rate hikes stretching well into the future.

"Despite elevated energy prices and hurricane-related disruptions, the expansion in economic activity appears solid," said the statement, which was adopted unanimously by the 10 FOMC members.

"Core inflation has stayed relatively low in recent months and longer-term inflation expectations remain contained.

"Nevertheless, possible increases in resource utilisation as well as elevated energy prices have the potential to add to inflation pressures," it said.

"The Committee judges that some further measured policy firming is likely to be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance.

"In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives."

Wall Street share prices rose as investors began to anticipate an imminent end to the Fed's hiking campaign, which began 18 months ago and has now taken US rates to their highest point since before a recession struck in mid-2001.

Some economists think the FOMC will end its hikes at the next meeting on January 31, while others see the fed funds going to 5.0 per cent or higher.

"The Fed finally did away with their policy accommodation phrase, in other words, that policy accommodation can be removed at a measured pace," said Michael Sheldon, chief market strategist at Spencer Clarke LLC.

"Instead they said that some measured policy firming is likely. I think investors are likely to take away from this that there is some light at the end of the tunnel," he said.

The Fed had signalled a looming policy shift at its last meeting held on November 1. Minutes from that session showed concern among some FOMC members of the "risks of going too far with the tightening process".

But analysts had said the FOMC faced a difficult balancing act in not binding Bernanke's hands while also not ruling out future rate hikes.

"If they retain the current language, they're pre-committing Bernanke to raise rates at his first meeting (on March 28)," Ethan Harris, chief US economist at Lehman Brothers, said before the FOMC announcement.

The main motive for a language shift, he said, "is that Greenspan will want to hand Bernanke a more flexible directive".