Interest Rate Hikes Expected in U.S. and Europe

Major world economies including the United States and Europe have poured a tremendous amount of money into their markets as pump priming measures, leading to fears over inflation.

Accordingly, the U.S. Federal Reserve Bank and the European Central Bank are expected to raise interest rates earlier than expected. The U.S. bond rate is also on a steep rise.

“The risk of rapid inflation at the end of the recession is a real risk,” IMF Managing Director Dominique Strauss-Kahn told a forum in Montreal Monday. “How are we going to dry up all the markets?"

"We still believe the global economy will see the turning point in September, October, beginning growth at the end of this year, and then turn positive in the first half of 2010. The world after the crisis is not that simple.”

World Bank President Robert Zoellick said the same day, “Injecting stimulus without fixing credit markets can amount to a sugar high.”

The Fed and the European bank, which injected huge liquidity into their markets to ease the credit crunch only a few months ago, have begun to recognize the side effects of their stimulus packages such as inflation and financial deficits.

“The very low interest rate policy for economic stimulus cannot be maintained forever,” European Central Bank Executive Board member Juergen Stark told a conference in Linz, Austria. “When the European economy shows signs of recovery, the ECB will raise interest rates immediately.”

Kansas City Fed President Thomas Hoenig said last week, “Now is the time to tighten Fed policy.”

“The recent rise of the U.S. bond yield (meaning the drop of the bond price) reflects that the market is concerned about inflationary pressure caused by the federal financial deficit and eased financial policies. Before inflation goes out of control, the U.S. needs to think seriously about balancing monetary policies.”

The rumor that the U.S. and Europe could raise interest rates earlier than expected is spreading fast. Peter Jankovskis, co-chief investment officer at Oakbrook Investments, said, “The Fed must inevitably raise interest rates to maintain the dollar’s value and the demand for U.S. bonds from foreign governments. There are concerns that the Fed may raise the benchmark interest rate earlier than expected among investors.”

The U.S. bond yield is forecast to rise amid fears over inflation and the Fed’s possible raising of interest rates. The 10-year bond yield, which had dropped to 2.05 percent at the end of last year, jumped to 3.85 percent Monday.

higgledy@donga.com