Optimistic Fed keeps interest rates on hold

The US Federal Reserve Board has headed off concern about an early rise in interest rates, saying that it expected to hold down borrowing costs for "a considerable period".

The Fed announced yesterday that it was holding base rates at the 45-year low of 1 per cent and that, while the economy was showing signs of improvement, the risk that already low inflation could drop further would be their main concern for the foreseeable future.

Stock markets welcomed the move, with the Dow Jones running ahead 75 points in the aftermath of the announcement. The index closed the session with its largest gain since the beginning of the month, up 140.15, or 1.5 per cent, at 9,748.31.

The decision of the Federal Open Market Committee (FOMC) to hold rates at current levels was expected, but the markets had eagerly awaited its comment on the outlook, with signs of improvement in the US economy.

The Fed acknowledged this economic improvement, saying that "spending is firming and the labour market appears to be stabilising".

However, striking a cautious note, the statement by the FOMC, the key policy-making body of the Fed, after its monthly meeting yesterday, said that the upside and downside risks to economic growth were roughly balanced.

And, in the crucial area of inflation, it said that "the probability, though minor, of an unwelcome fall in inflation exceeds that of a rise in inflation from its already low level.

This would remain the predominant concern for the foreseeable future."

For this reason, the statement added that "policy accommodation can be maintained for a considerable period", a clear signal that, despite an improving economy, an interest rate increase is still a long way off. The Fed statement indicates that it wants to wait for much clearer signs of recovery before moving rates higher.

The timing of an increase in interest rates is now a key issue for debate in the US, with most analysts believing there will be no move upwards until well into 2004 at the earliest and some even believing it will be delayed until after the November 2004 presidential election.

Recent comments from the US Treasury Secretary, Mr John Snow, who was quoted as saying he would be "frustrated and concerned" if US interest rates did not rise over the coming months, caused some confusion in the markets.

Against this backdrop, yesterday's policy statement gave out a message of policy consistency from the Fed, meeting an initially favourable response from financial market analysts.

Bond prices rose in the immediate aftermath of the announcement - with investors reassured that interest rates would remain low as the Fed took a cautious view of economic prospects.

The FOMC first warned of the danger of deflation in a statement after its May meeting and its decision to hold interest rates as low as 1 per cent shows that it took this threat seriously.

For the moment, the Fed seems determined to keep rates low, despite increasing signs of recovery.

Forecasters say the economy probably grew at around a 6 per cent annual rate in the third quarter,which would be the fastest pace since late 1999.

While growth is likely to moderate as the impact of recent tax cuts fades, consensus forecasts look for a solid 4 per cent pace of expansion through next year.

Reports yesterday underscored a picture of an economy with brightening prospects.

The Commerce Department said orders for long-lasting manufactured goods rose a strong 2.6 per cent, excluding a drop in defence demand, while the private Conference Board said its October index of consumer confidence rose.

"Our economy is showing signs of broad and gathering strength," President George W. Bush told a news conference.