Expect the world to follow MPC's lead

The rise in interest rates is part of a global trend that will run at least until the end of this year
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The Independent Online
THE GLOBAL interest cycle is clearly turning upwards. Our own move this week can be explained in terms of concern about UK house prices or the bounce in demand. But it is really more helpful to see in its global context, for this is just one quite small signal that the next year or so will see a gradual tightening of monetary policy around the world.

Thus the US Federal Reserve is widely expected to increase rates in the near future, while the next move from the European Central Bank will also almost certainly be up. The Japanese response is less clear, but its economy is so out of phase with the rest of the world that the rates set there are not going to have a material knock-on effect.

This upswing in the global cycle raises several questions: for example, why is it happening, what are the implications for the world economy, and where and when might it end? The "why?" question is relatively easy to answer. Have a look at the chart on the global economy. The great fear of a few months ago - that the US economy would slow down before the European and East Asian economic zones picked up - seems to have receded. The US economy has continued to grow steadily, the core Continental European countries are growing adequately, and there are some signs of a recovery in emerging East Asia.

As a result, growth prospects for the global economy this autumn are secure. Growing economies do not turn down suddenly. Even if something goes radically wrong in the next couple of months, there is enough momentum to carry us through well into next year. If that is so, the world is likely to need higher interest rates to control the growth, maybe to rein it in a bit.

The next issue is how growth might be balanced over the rest of this year and into next. One of the really remarkable features of the past few years is how the US has outpaced core Europe. The second growth shows just how sustained this out-performance has been - that there have only been two three month periods in the last eight years when the euro-zone has grown faster than the US. But it also shows something else. The out- performance of the US - the extent to which it has been growing faster than the euro-zone countries -- seems to be diminishing. Given that there is much less slack in the US economy than there is in the continental European ones, you would certainly expect that, and the forecast is for the differential to disappear by the end of next year.

If this is right, and there are two big provisos that need to be made, then the world economy is in for another six months of monetary tightening, maybe 12 months or even more. The tightening will take place first in the US and the UK, for the UK behaves like the other Anglo-Saxon economies, not like the continental European ones. But then, after a lag, higher interest rates in the US and UK will be followed by Europe. As next year rolls forward and growth in the US comes off, we would be looking for dollar rates to ease again, but perhaps not before well into 2000. In the UK we would get rates up to more than 6 per cent, before they too turn down, probably about the middle of next year. Meanwhile, in Europe the rise in rates would take place later and be more muted: there would be gradually rising interest rates right through 2000.

Now for the provisos. All this neat cyclical picture assumes that there are no shocks to the system. Interest rates move in nice cyclical waves, sometimes performing in phase with each other, sometimes out of phase, but always moving in slow motion. The trouble is, while most of the time that is indeed the way interest rates behave, there are occasionally things which upset the cycles. There are any number of potential shocks and the nature of a shock is that it cannot be predicted. But there are two candidates which, looking six months forward, ought to be on the radar. Neither are original; both are worth noting.

The first is the US stock market. It is impossible to say anything sensible about the present level of the market except that it is very high by historical standards. You can have a debate about whether historical standards are appropriate or not and about alternative standards, but in the context of the global interest rate outlook it is really more helpful just to note this simple point. A sharp fall in the market would have profound implications for US growth and hence for interest rates. If Wall Street collapses it will lead to interest rate cuts, not just in the US but around the world.

The second potential shock is the Y2K or millennium bug. To some extent, the extra resources going into preparation for Y2K will have been increasing demand right now. We don't know how big this effect is, but estimates have been up to 0.5 per cent of global GDP. Even if it is half that, it is helping nudge growth. Next year, whether or not there are actual severe Y2K problems, there will be some negative impact on activity. Some projects which have been brought forward to 1999 will not take place in 2000. And fear of computer problems will encourage some people to put off projects planned for early 2000 into later in the year.

If the effect is towards the more severe end of the spectrum, it will have a huge impact on interest rates. Central banks are already running the printing presses hard to push extra cash into the system. Irrespective of the demand for physical cash, they will need to supply more liquidity to the banking system. Expect rates to be eased dramatically in the early part of next year if there is really serious disruption, for pumping in money is really the only policy weapon the authorities have to cope with this. If, on the other hand, disruption is slight, then there may be no direct monetary impact, and merely an indirect one if output falls a bit in the first half of next year.

The one to be absolutely clear about, though, is that this move by the UK is not an isolated, capricious move. Whatever your judgement about the wisdom of the Bank of England, or the timing of the rise, it is part of global trend which will run at least to the end of this year. More rate rises around the world are on the way.