US Fed hints at more rate rises

INTEREST rates in the US look set to continue going up in 2005, according to the Federal Reserve. Hawkish minutes from the Fed's open market committee meeting, which put rates up to 2.25%, reveals striking concern from the committee's members about inflation and increases the likelihood of more rate rises this year.

The Fed's committee indicated that the weakening dollar and high energy costs could spark another period of higher inflation. The strength of the language used by Federal Reserve sent a shock rate through the financial markets last night and saw shares in New York close down on the news. The Dow Jones Industrial Average dropped almost 100 points and the dollar rose to $1.327 against the Euro.

Some dealers said they were reminded of comments by Fed chairman Alan Greenspan in 1996 which similarly caused alarm in the financial markets when he described the performance of shares as 'irrational exuberance'.

Fed officials have indicated in the past few weeks that the five rate increases since June have been bringing rates back to a neutral level, thought to lie somewhere in the 3-5% range. However, the central bank has hesitated to be more specific on what a neutral level might be. The key Fed funds rate has gone from a low of 1% in 2001 to 2.25%.

'Some members said the economy is close to potential, which suggests we might soon see inflation pressures take hold,' said Christopher Low, chief economist at FTN Financial. Another economist, Ian Shepherdson of High Frequency Economics in New York, said he thought the tone of the committee's minutes was surprising: 'The tone of these minutes is notably more hawkish than in November.'

'Fears of future inflation risk are also more apparent in these minutes, with members citing the drop in the dollar and slower productivity growth, and some even suggesting the economy could soon be operating close to potential,' Shepherdson added.

Other market analysts admitted that they had been expecting to see some indication in the minutes that rates were near to their peak but they were disappointed. 'Some people were expecting some discussion of a pause. There's no mention of that here," said Jay Bryson, global economist at Wachovia Corporation.