World economy to face new pressures as US rates rise

Thu Jul 1

WASHINGTON (AFP) - World economic growth may be crimped as the United States enters an era of gradually rising interest rates to choke inflation, analysts warned.

US Federal Reserve chairman Alan Greenspan and fellow policymakers pushed up the main short-term rate by a quarter point to 1.25 percent Wednesday, the first increase in four years.

It is the first increase in an expected series, gradually returning the federal funds rate, which banks charge each other overnight, to normalcy -- about 4.0 percent at current inflation -- by the end of 2005, economists say.

"I think it surely will have a global impact," said Wells Fargo Bank chief economist Sung Won Sohn.

Inflationary expectations would be milder globally, and pressure for rising interest rates would increase, particularly on the European Central Bank, Sohn said.

Higher US rates also would likely boost the dollar, easing pressure on European exporters.

But overall, it could act to dampen global growth, he said.

"Housing would be a good example," Sohn said. "Housing is not going to do as well with rising interest rates."

A house price "bubble" in the United States and Europe was unlikely to grow larger as pressure grew on interest rates, and "it could even deflate slightly as is happening in Australia," he said.

US borrowing costs remain stimulative for now, however, said Wachovia global economist Jay Bryson.

"As domestic demand in the United States continues to expand, continues to grow, that will continue to provide locomotive support for the rest of the world," he said.

Higher US interest rates could dampen financial flows to the developing world by making US investments more attractive, he said.

In a few months, US Treasury bond yields had already climbed more than a full percentage point in advance of the expected federal funds rate boost, Bryson said.

"That makes portfolio investment in developing countries relatively less attractive," he said.

But direct foreign investment -- such as building of factories overseas -- was less affected by interest rates.

"That won't really slow down until profit growth starts to slow down. In general I believe foreign direct investment flows will remain pretty strong," Bryson said.

Among the major economies, Europe is unlikely to follow the Federal Reserve's lead until as late as 2005 because the economic data are mixed and inflationary pressures appear to be easing along with oil prices, analysts said in Frankfurt.

The Bank of Japan's policy board voted unanimously last week to leave its ultra-easy monetary policy unchanged.

But while the short-term rate in Japan was sure to be stuck until deflation dissipated, longer-term Japanese rates were creeping higher on expectations that inflation would slowly re-emerge, Bryson said.

"If the globe is growing, Japan is going to partake in that through exports and so rates are clearly coming up in Japan as well."

For Asia, China's attempts to brake the economy would be a more serious problem for emerging economies in the region if Beijing went too far and brought growth to a halt, the economist said.

"But providing China does not slow down too much, I would think that growth rates in Asia ex-China will be stronger than growth rates in Eastern Europe or Latin America in general," he said.

The International Monetary Fund has predicted world economic growth will surge from 3.9 percent last year to 4.6 percent in 2004 -- the fastest since 2000 -- and 4.4 percent in 2005.

At the last IMF-World Bank meetings here in April, top IMF policymakers urged countries to prepare for rising rates by moving more debt into long-term obligations.

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