US Central Bank Raises Interest Rates

The Federal Reserve, the US central bank, yesterday shrugged off the possible economic effects of Hurricane Katrina and raised borrowing costs for the 11th time.

The Fed raised its benchmark Fed Funds rate by a quarter point, as generally expected on Wall Street, to 3.75%. It began raising rates from a 46-year low of 1% in June of last year, at what it has repeatedly described as a "measured pace", in a bid to prevent robust growth generating inflation.

There had been some feeling among Fed watchers that it may be tempted to hold off its path of a gradual tightening of monetary policy because of the uncertainty about the economic impact of Katrina. But a majority felt the Fed would raise rates again and a decision to break the pattern would have unsettled the financial markets.

The hurricane knocked out about 10% of the country's refining capacity and about a quarter of its oil production in the Gulf of Mexico and sent petrol prices sharply higher at US pumps, raising fears that consumer spending and confidence could be knocked back. There is already evidence that confidence has taken a dive.

But oil prices have recently touched record highs, putting upward pressure on inflation. Fed chairman Alan Greenspan has become increasingly concerned about booming house prices, which are rising at record speed, making the bank wary of leaving rates at what is still sees as expansionary for the US economy.

Data last week showed US inflation rose 0.5% in August, the same as July, with the bulk of the rise being a leap in energy costs. Stripping those out leaves a so-called "core" inflation of 0.1%. But economists are fretting that the August numbers were collected before Hurricane Katrina and rising energy costs since then could feed into higher core inflation in the next couple of months, something the Fed is only too aware of. But the same petrol and air ticket price rises have hit confidence. Last Friday's Michigan confidence index plunged to its lowest since 1992, worse even than after September 11, 2001.

"What matters now is how actual spending reacts and where gasoline prices go from here," said Nariman Behravesh, chief economist at consultancy Global Insight. On the former, he said, consumer spending could remain subdued for some months as Americans are spending far more on petrol than they were a few months ago.

But he added that he thought the high point may have been already passed for petrol prices. "If this proves correct, confidence should recover and its September decline would signal a temporary slowdown in spending growth - but not a recession."

Oil prices, which fell sharply late last week, jumped $3.50 a barrel on Monday on fears that another tropical storm could hit the US coast. Yesterday they dipped a dollar to about $66 a barrel for US light crude but remained within sight of an all-time record of $70.85 struck in the immediate aftermath of Katrina.

Mr Greenspan is expected to retire in 2006 and has only three more meetings of the Federal Open Market Committee before the end of his term. Fed watchers think the veteran Fed chief is keen to leave rates close to their long-term average of between 4% and 4.5% and prevent the housing boom running out of control. Most analysts expect rates to finish this year at 4%.

Jan 2001 Fed cuts rates sharply, from 6.5%, in wake of dotcom bust

Sept 2001 Fed cuts rates further, from 3.5%, following attacks on World Trade Centre

June 2003 Rates cut to 46-year low of 1% in wake of second Gulf war

June 2004 Fed begins raising rates from 1% as economy recovers

August 2005 Hurricane Katrina strikes Gulf of Mexico