RIYADH, 24 May 2004 — Last week’s crash of global stock markets on fears of expected rates increases were forgotten as they tackled other “bombshells”.
On Monday, following more news of geopolitical tension in the Middle East, markets across the world lost ground, the Dow shedding 108 points and the Nikkei losing 344 points. This was in reaction to the bomb explosion in Iraq that killed the head of the Iraqi governing council.
The instability grew as four smaller bombs exploded in Ankara and Istanbul, making the markets nervous about security. Recent record highs in the price of oil and no signs of a sustainable global economic recovery further weakened investor confidence.
US Federal Reserve Bank officials released cautious expectations with comments of a “gradual pace” in rising interest rates. Ben Bernanke, Federal Reserve Board governor said: “Economic developments over the next year are likely to be consistent with a gradual adjustment of policy.” He added, “...core inflation appears likely to remain in the zone of price stability during the remainder of 2004 and into 2005.” Bernanke re-iterated comments from the May 4th meeting of Fed officials, saying interest rates would move up “at a pace that is likely to be measured”. Dallas Fed president, Robert McTeer who said he was not “overly concerned” about inflation.
In response, US Treasury prices went up while yields moved down. This tackled economists expectations that the Fed had waited too long to increase interest rates. Expectations of a (still likely) US interest rate hike dissipated this week amid signals of an ongoing economic recovery, but red flags have also popped up indicating a possible overheating of the recovery.
The British are usually prudent with a “wait and see” approach, but this time they are leading the US with interest rates increases.
The minutes from the Bank of England’s policy meeting indicate that the nine-member committee upped interest rates by 25bps and are looking at a landmark 50bps rate hike in the future. This news came out amid reports of inflation picking up in April and mortgage lending rising at a record pace in April. This inflationary pressure may prompt a rate hike as early as June.
The US may choose to wait and see as London makes its move, considering the US economic recovery still looks stronger than their trans-Atlantic colleague.
(Khan H. Zahid is chief economist and vice president at Riyad Bank. He is based in Riyadh.)