Fear of rising interest rates sends markets sharply lower

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The Independent Online

Stock markets plunged around the world yesterday as doubts about the new economy boom were compounded by fears of rising interest rates.

Stock markets plunged around the world yesterday as doubts about the new economy boom were compounded by fears of rising interest rates.

Old and new economy stocks fell in tandem as investors withdrew to safety at the end of a bruising week for equity markets. A broad reassesment of the prospects for stocks seems to be under way in America, with a dramatic effect on prices.

A surge in US inflation prompted fears that interest rates might have to rise faster and for longer than had been expected in America. The Nasdaq Composite fell by 250 points, some 8 per cent, having fallen more than 20 per cent this week and 30 per cent from its high a month ago. The Dow Jones Industrial Average was down about 330 points. In London, the FTSE-100 followed the US indices downwards. It ended down 178.9 at 6178.1,having fallen as much as 207 points earlier. Other European markets also fell. The sharp share price falls came as Mervyn King, deputy governor of the Bank of England, signalled UK rates might also have to go up. He issued the clearest warning so far of the possibility of further turmoil in stock markets and currency markets.

There had been excessive optimism about the potential for the New Economy, especially in the US, he warned. "If optimism has run ahead of reality, then at some point an awkward downward adjustment to spending must take place," Mr King said. "The message for policy is that it is important not to let domestic demand grow too rapidly for too long. The longer the correction is left, the sharper the required adjustment will be," he said, in a signal interest rates might need to rise again soon despite the recent complaints from business and unions.

The deputy governor issued the unusually frank warning, at a business dinner in Plymouth last night, just ahead of the weekend meeting of G7 finance ministers and central bankers in Washington. He said the imbalance in the British economy, with service industries thriving while manufacturing suffered the impact of the strong pound, reflected the serious global imbalances due to be debated at the meeting.

US inflation figures served as yesterday's catalyst for a collapse on Wall Street. The consumer price index rose 0.7 per cent in March, which was largely the result of much higher energy costs as oil prices surged. But the core rate, which excludes energy and food, also rose sharply by 0.4 per cent - the highest in five years. Both figures were higher than markets had been expecting.

A further rise in US interest rates had been expected, as the US Federal Reserve acts to clamp down before inflation takes its toll. But analysts had started to assume that the Fed would act only once or twice more. The evidence that price rises might be feeding through already startled investors, and specualtion centred on a 50 basis point increase in rates when the Fed next meets.

The underlying reason for the market's precipitate fall, though, was the broader concern which has swept the market all week, centring on new economy stocks but increasingly spreading to industrial and financial stocks. Many new economy stocks have produced disappointing returns; some are looking financially weak and may not survive for much longer. Dealers said that many investors were pulling out of the market, fearing that its decline could not be stopped.