The Hindu Business Line : Fed funds: Upward march will continue

The minutes of the last Fed meeting stirred the beginning of doubts in markets as to whether the Fed would continue to raise rates in the coming meetings, as it had in the past eighteen months since June 2004. Some members of the Federal Open Market Committee (FOMC), which makes the Fed's interest rate moves, were apprehensive of further tightening.

This view, though, did not find a place in the usual post-meeting Fed statement, where the language was more or less identical to that of the previous meetings. It reiterated that inflation expectations remain "contained" and monetary policy "accommodative." The economy kept its momentum despite the hurricane-caused devastations.

Meanwhile, what of the recent economic data? After a slight blip in October, November's numbers show that growth is on track. All the much-watched indices — jobs, retail sales, and business and consumer confidence — were significantly better. Productivity keeps improving, which means wage increases can be absorbed without a rise in unit costs. The GDP for the third quarter was revised upwards, north of 4 per cent. Headline inflation is rising but when food and energy are removed, "core" inflation remains mute — a point repeatedly drawn attention to by Mr Greenspan.

The European Central Bank is not impressed. It chose to ignore the advice of some European Union Finance Ministers and, at its latest meeting, the ECB raised its repo rate to 2.25 per cent from 2 per cent. But, going by the utterances of the ECB President, Mr Jean-Claude Trichet, and some of his colleagues, this is not necessarily the first of a series of upward moves. The ECB's action seems to be vindicated by the somewhat stronger data emerging from Europe in recent weeks.

There is little doubt that global growth is driving up energy and commodity prices. More significant, it is probably restoring some pricing power to business. We have seen the best of times as far as inflation is concerned. Competition will ensure that there is no automatic or easy pass-through of costs to prices, but at least a modest rise in the general price level is a certainty. Inflation risk will surely drive interest rates and monetary policy, not only in the US, but also the world over. Coupled with the overall economic buoyancy, it seems a cinch that the Fed will not backtrack from its measured steps to raise rates.

Expect Mr Greenspan to round off his tenure with Fed funds at 4.5 per cent, sanctioning an increase of 25 basis points each in his remaining two meetings.

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