Interest rate fear spooks markets

SHARE PRICES tumbled on both sides of the Atlantic yesterday in the face of growing fears that US interest rates are heading up. Signs of inflationary pressure in the US economy have undermined investors' confidence in a "new era" of perpetual high growth and low inflation.

The FTSE-100 index ended down 148 points or 2.4 per cent at 5,978.4, below the psychologically important 6,000 mark.

On Wall Street the Dow Jones was 104 points lower at 10,604.17 during morning trading. Technology stocks bore the brunt of the decline, with the Nasdaq slumping 52 points to 2,467.51. The Dow Jones index has now fallen nearly 6 per cent from its mid-July peak. The Nasdaq index has fallen 14 per cent.

Stephen Lewis, chief economist at Monument Derivatives, said: "There is a general feeling that the game may be over. The long bull market in equities that has been taking place ever since 1991 is drawing to a close." Analysts predicted further falls this week with figures on retail sales and producer prices expected to confirm inflationary pressures.

Alan Greenspan, chairman of the US Federal Reserve is expected to raise interest rates after its 24 August meeting and again in October. Few strategists expect shares to make any headway before then. Trevor Greetham of Merrill Lynch said: "We are at a dangerous time. I don't know how much of their gains share prices will give back, but we could be in for a nasty correction." Anna Mackman at CSFB said: "A lot of markets have been hovering near key support levels. The FTSE falling below 6,000 has been a real shock."

The Bank of England presents its Inflation Report this morning, amidst market expectations that UK interest rates will also have to climb at some point. The City will look to the Bank to provide a clear signal on the direction of rates, as predictions yesterday ranged from a quarter point cut to a 2 per cent rise.

The Bank's report is expected to forecast inflation will be broadly in line with its two-year target of 2.5 per cent but will emphasise that lagging disinflationary pressures will mean an undershoot of the target in the near-term.

It may hint that rates will have to go up but stop short of signalling an imminent hike. The financial markets are pricing in rates of 6.95 per cent a year from now, based on an analysis of three-month sterling futures. Lande Abisogun, Europe analyst at IDEAglobal.com, said strong hints of an imminent UK rate rise could knock the FTSE as low as 5,600. Yesterday a survey of fund managers who control pounds 1.13 trillion of assets showed they expected a 0.25 per cent hike in rates over the next year. Six out of 10 fund managers polled by Merrill Lynch expected the next move in rates would be up.

Meanwhile the Confederation of British Industry said there was room for another cut if the pound stayed at its current levels. Its survey of manufacturing industry showed output fell in every region in the latest quarter, although confidence was at its highest level for 18 months.

Stephen Hannah, chief economist at IBJ International, said the lack of any serious inflationary pressure meant the Bank should "not be too trigger-happy".

Not all analysts were alarmed. Robin Griffiths at HSBC in New York said: "August was always going to be the time when optimism was out of style, and many investors are on holiday."