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The Federal Reserve finally called a halt to its two-year monetary tightening cycle last night, leaving its key interest rate on hold at 5.25% in the face of a slowdown in the world's largest economy. Its decision came in spite of a renewed surge in oil prices to a record of close to $79 a barrel, which economists fear could push inflation even higher, something the Fed is keen to avoid.
Under its former chairman, Alan Greenspan, the Fed began raising rates in successive quarter-point moves in mid-2004, when they were at 1%. It has since raised them 17 times to the current level, the last move coming at its June 30 meeting, with Ben Bernanke, who took over in February, in charge.
Financial markets, although broadly expecting rates to be held, reacted swiftly. The Dow Jones industrial average gained about 40 points on the news to stand at 11275 while the dollar slid more than a cent against the pound to $1.913, a 15-month low. Both were later reversed.
In a statement accompanying its decision, the Fed's interest-rate committee noted that growth had slowed and said it felt inflationary pressures were likely to moderate over time, but it nevertheless left the door open to further rate rises:
"The committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth."
Analysts said it was too early to say the Fed had finished raising rates. "They are leaving the door open to a hike down the road - a pause as opposed to the end of the cycle," said Shaun Osborne, strategist at Scotia Capital in Toronto.
Until the end of last month, most economists had expected that the Fed would add an 18th rise and push rates up to 5.5%, the highest in more than five years. But sentiment changed sharply with the publication of data showing annualised economic growth slowed to 2.5% in the second quarter of the year from a steamy 5.6% in the first.
A slowdown in growth and, in particular, the country's overheating housing market had been the aim of the Fed's long run of rate increases and this now seems to be happening. Sales of new homes and existing homes fell back in June while new mortgage applications have tumbled to their lowest in four years. News last Friday that unemployment had risen also dented expectations that the Fed would raise rates again yesterday.
The Fed's dilemma is that inflation, which is its ultimate concern and which tends to react more slowly to interest rates than growth, is still pushing ahead, driven largely by rising energy prices. The Fed's preferred inflation measure is at 2.4%, well above the central bank's "comfort zone" of 1-2%.
The sudden and unexpected closure of BP's huge Alaskan oil field this week has added to the market's jitters and saw the price of London Brent crude hit a new peak of $78.65 a barrel yesterday, though it later slid back below $78. Pump prices are about $3 a gallon in the US and there are signs that the higher prices are feeding through into higher air fares and transport costs. Also, data out yesterday suggested that labour costs were rising much faster in America than had been thought, which economists said suggested that wage pressures could be building and could push up inflation.
The Fed's decision to call a halt to its rate rises, for now at least, comes at a time when other central banks around the world have been raising them. The Bank of Japan recently ended its zero-rate policy and raised rates to 0.25%. Last Thursday both the Bank of England and European Central Bank raised rates by a quarter of a point, to 4.75% and 3% respectively. Central banks are concerned that the very low interest rates of recent years have stoked up the world economy to the extent that inflation could run out of control.
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