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US Federal Reserve is right to raise interest rates, yet risk remains

A major employment boost and hourly wages rising suggest this is the time to act, but the US economy is not free of problems

Janet Yellen’s finger is poised over the button. The US Federal Reserve will finally take the plunge and raise interest rates when it meets again just before Christmas. The days when borrowing costs were kept at zero are coming to an end.

That was the interpretation Wall Street was putting on Friday’s news that the world’s biggest economy created 271,000 extra jobs in October and, barring a big domestic or global crisis in the next month or so, it is almost certainly the correct one.

The reason for the heightened speculation about a Fed tightening was that the employment news did not so much exceed expectations as smash them.

After a couple of months in which employment growth had been disappointing, the markets were betting on non-farm payrolls – all sectors barring agriculture – increasing by 185,000 last month.

The number of jobs created in September was revised down a bit, but that was more than compensated for by the October increase and by two other pieces of information that will make the Fed think the labour market is getting stronger.

First, the unemployment rate edged down from 5.1% to 5%, within the range that the Fed categorises as full employment. Second, hourly wages were up by 0.4%, taking the year-on-year increase to 2.5%. That might not sound too impressive, and indeed is quite poor for a US economy now into the seventh year of recovery, but it is the strongest annual increase since 2009.

If the Fed moves next month, the search will be on for the next major central bank to raise rates. Given that the European Central Bank and the Bank of Japan are still increasing the amount of stimulus they are providing, every pronouncement by members of the Bank of England’s monetary policy committee will be scrutinised.

Threadneedle Street’s quarterly inflation report on Thursday prompted some analysts to assume the MPC would delay raising rates until early 2017. Markets are sure to bring forward their expectations of the first move by the Bank to 2016, and perhaps the first half of the year at that.

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There is a risk for the Fed in all this. Aside from the exceptionally strong jobs data, the economic news from the US has not been all that special. Other central banks that have raised interest rates have quickly come to regret the decision.


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