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US interest rates rise but inflation mystery continues

US interest rates rise but inflation mystery continues

The US Federal Reserve increased interest rates for the third time this year on 13 December, and signalled three more hikes to come in 2018, despite inflation remaining stubbornly low.

The Fed base interest rate is now 1.25 per cent, compared with 0.5 per cent in the UK.

The chair of the Federal Reserve, Janet Yellen, said she sees few warning signs about the health of the US economy.

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But two members of the Federal Open Markets Committee (FOMC), the committee of the US central bank that sets interest rates, voted against the decision to put rates up, citing continued low inflation.

Core inflation in the US, a measure that strips out the more volatile components of the inflation index and so is a reliable guide to the future movement of prices, actually fell from 1.8 per cent to 1.7 per cent in November.

The Federal Reserve target 2 per cent for this number.

Traditional economic theory suggests that interest rates should rise to stop inflation getting out of hand, and lower than expected inflation has prompted two of the members of the FOMC to oppose more rate rises.

Similarly usually as unemployment falls, inflation should rise, in what is known as the Phillips Curve. But US unemployment has fallen consistently over the past year, without inflation rising.

Steven Gerlach, chief economist at EFG Bank said: “Earlier this year Janet Yellen described the fall in the inflation rate as ‘a mystery."

He said the causes of falling inflation may be structural. He said the move to chain stores and catalogue shopping in the early 20th century caused a prolonged fall in retail prices, and the same may be happening now with the rise of internet shopping.

Michael Grady, senior economist at Aviva Investors, said he thinks interest rates in the US will rise at a faster pace than the market is currently expecting as higher inflation will come through in 2018.

Jake Robbins, a global equities fund manager at Premier Asset Management, said if rates continue to rise in a gradual way, it will be good for equities, but if inflation forces a faster pace of rate rises, then market volatility will increase.

David.Thorpe@ft.com