US interest rates may be on the way back up following the Federal Reserve's shift in its monetary policy stance, now indicating a "bias" towards raising interest rates. The Fed cut interest rates by three-quarters of a percentage point last autumn to restore calm to financial markets following the Asian crisis. That policy worked better than anybody had expected, but it did mean that the US economy has been growing remarkably quickly.
There have been fears that inflation would rise, but, so far, that has not happened, encouraging even the Fed chief, Mr Alan Greenspan, to talk recently of the so-called "new paradigm", in which productivity increases stave off price rises. But last Friday the US consumer price data for April began to worry the markets, when inflation rose by 0.7 per cent in one month, the biggest jump for nine years.
The core rate, stripping out the rise in oil prices was 0.4 per cent, the highest for four years.
Of course, too much cannot be read into one month's data. But the figures will certainly have given traditionalists at the Fed, who dismiss the "new paradigm", some ammunition.
Despite last week's figures, many economists do not believe that inflation will pick up to any significant extent. According to Mr John Beggs, chief economist at AIB, the Fed is likely to remain on a "tightening bias" - a technical term for a readiness to increase interest rates - for this year, but may not actually have to increase rates.
He believes that the next move could still be another cut in interest rates next year, when inflation fails to turn up and growth is below 3 per cent. He pointed out that the Fed had a tightening bias from May 1997 until late 1998, when it actually cut rates.
The move is not particularly good news for either Europe or Japan. As Mr Beggs pointed out, if the US does raise interest rates and slow its own economy, it will not be good news for recovering Asian economies or the sluggish markets of continental Europe. If it also led to a stronger dollar and a weaker Euro, ECB policy-makers may be reluctant to cut rates further and risk weakening the Euro even more.
Of course, an overheating economy in the US would not be in the interests of the global economy. And the US economy has been growing at an annualised rate of some 7 per cent in the first three months of this year, which practically everyone agrees is unsustainable. One danger is that the Fed will wait too long, serious inflationary pressures will emerge and interest rates would then have to be raised by far more than would otherwise have been necessary.
Most analysts, however, are ruling out a sustained pick-up in inflation. But the markets will be watching carefully when the Fed meets again on June 30th and will be keeping a very close eye on inflation figures.
