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Last Updated: Thursday, 29 January, 2004, 17:33 GMT
The politics of US interest rates

Analysis
By Steve Schifferes
BBC News Online economics reporter

Greenspan
Alan Greenspan: No deal on interest rates
The Federal Reserve has changed just two words in its assessment of the US economy. But that was enough to spook financial markets and raise the dollar.

The Fed was expected to keep interest rates on hold until after the US presidential election in November.

But now it says it will 'be patient' rather than wait 'for a considerable period' before raising rates.

Economists now believe that it is likely that the US central bank may act in June to raise US interest rates.

Changing the bias

In its statement, the Federal Open Market Committee (FOMC) said its decision to keep rates on hold was unanimous.

Signs of growth:
State of the US economy

"With inflation quite low and resource use slack, the committee believes that it can be patient in removing its policy accommodation," it said.

Previously the committee, led by Alan Greenspan, had said it would keep interest rates low for a "considerable period", a phrase it had been using since last August.

The FOMC added: "The committee perceives that the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal."

US interest rates have now remained unchanged from their 1958 low since June 2003.

Political balance

However, interest rates worldwide are gradually moving upwards, especially in the UK, Canada, and Australia, as the worldwide recovery gathers pace.

The Fed was expected to make a move by the end of the year as US economic growth has begun to rebound.

But now political elements may be entering into their decision-making.

The Fed has traditionally been reluctant to raise interest rates during a Presidential election campaign, for fear of appearing to be political and influence the election result.

That would rule out a rate rise after its July meeting, probably until December 2004.

But that could leave it too late to react to any further changes in the US economy.

Nursing the recovery

Some Democrats, including presidential contender Howard Dean, already believe that Alan Greenspan, the Fed chairman, is pro-Republican.

Howard Dean
Howard Dean has accused Mr Greenspan of being "too political"
Mr Greenspan, who was originally appointed by Ronald Reagan in 1986, has been endorsed by President Bush for re-nomination for another four year term starting this spring.

And there is no doubt that the Fed's decision to keep interest rates so low, for so long, has contributed to the growing US economic recovery.

So too, at least in the short-term, have the tax cuts introduced by the Bush administration.

Last year, Mr Greenspan was highly critical of some of those tax cuts in the context of a growing budget deficit - leading some to suspect that Mr Bush would not re-nominate him.

Now, relations between the President and the central banker seem to have improved.

Mr Greenspan went out of his way at a recent conference in London to defend the US from charges that it is undergoing a jobless recovery, pointing out that millions of jobs are created each month, and that the flexibility of the US labour market is a key reason for its economic success.

Economic fundamentals

Many economists believe that there is still substantial slack in the US economy, and low inflation, giving the Fed a margin of error before raising rates.

But as unemployment gradually begins to decline, pressures on wages and costs may well rise.

Other factors could also have been on the Fed's mind when it effectively warned the markets that it might take action later.

The plummeting dollar, although boosting US exports, will eventually cause an increase in inflation by raising the cost of imported goods in America.

Higher rates would strengthen the dollar, which has been plunging on international markets, threatening the export-led recovery in Japan and Europe.

The rise in long-term interest rates - as markets react to the Fed's statement - will also help cool the US housing market, where house prices are rising at the fastest pace in a generation.

Ultimately, the rising deficit could also impact on the price of money, as investors fear that the federal government will be forced to issue more bonds.

So the economic judgement is finely balanced.

Nevertheless, it may be that preserving the Fed's long-standing tradition of political impartiality is now uppermost in its mind.




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