The Federal Reserve has signalled its concern over rising inflationary pressures in the US economy by announcing a shift in its policy stance towards a greater readiness to raise interest rates.
The US central bank's policymaking open market committee (FOMC) left short-term interest rates unchanged at its meeting yesterday but said its members had agreed to move to a "bias" towards tightening monetary policy.
The move does not necessarily mean that there will be an early increase in interest rates, but it gives an indication of where the Fed's policy-makers see the overall direction of the economy and the policy response that might be needed.
"While the FOMC did not take action today to alter the stance of monetary policy, the committee was concerned about the potential for a build-up of inflationary imbalances that could undermine the favourable performance of the economy, and therefore adopted a directive that is tilted toward the possibility of a firming in the stance of monetary policy," the Fed said.
Markets reacted negatively to the news. Within minutes of the announcement, the Dow Jones Industrial Average, which had been in positive territory had fallen by more than 70 points to 10,841. It later slipped marginally further, closing at 10,836.95, although this was just 16.52 points down on the previous evening's close. Bond prices mostly held steady, following some sharp falls in recent weeks in anticipation of the change, although the price of the benchmark 30-year US Treasury bond fell.
It was the first time the Fed had chosen to make its policy bias public immediately after the open market committee meeting. In the past, the stance had not been known until the publication of the committee minutes, six weeks or more after the meeting. But in a move aimed at improving transparency, the Fed said earlier this year it would begin announcing immediately changes in its policy stance when it deemed it important for markets to know of the shift.
The announcement came against a background of continuing strong growth in the US economy. Gross domestic product grew at an annual rate of more than 5 per cent in the six months to the end of March, and the unemployment rate has fallen to 4.3 per cent, close to its lowest level in 30 years.
Until yesterday's meeting, the Fed had not seemed unduly concerned about the inflationary risks of such rapid growth and tight labour markets. The central bank cut interest rates by 0.75 percentage points last autumn in response to international financial turmoil, and since then the open market committee has maintained a neutral policy stance, indicating it felt the risks to the economy were evenly balanced between inflation and recession.
But last week, in what some economists saw as an ominous sign that the long-feared inflationary upturn had arrived, the Commerce Department announced that consumer prices had risen by 0.7 per cent in April, the largest monthly leap in nine years.
In some ways, that figure was an aberration, apparently distorted by exceptional factors, including a sharp rise in tobacco prices and an expected increase in oil prices.
But yesterday's decision indicates that, on balance, Alan Greenspan, the Fed chairman, and most of his colleagues believe the balance of risks has shifted in the past few months and inflation has become a significant threat again. "It means the Fed has become more watchful about inflation, as it was prior to the global financial crises of the last year or so. The Fed is focusing on the domestic economy," said Ms Kathryn Kobe, senior economist at Joel Popkin and Co.
