Rate rise fears spark shares sell-off

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Markets slumped yesterday, spooked by fears of rising inflation and higher interest rates on both sides of the Atlantic, after stronger-than-expected US inflation data and news that a Bank of England policymaker had called for an interest rate rise this month for the first time in a year.

The FTSE 100 suffered its biggest one-day loss since September 2002, closing down 170.7 points, or 2.9 per cent, at 5,675.5. All FTSE 100 stocks were down on the day. The blue-chip index has fallen 7 per cent over the past six trading sessions.

Metals in London, which have soared to record highs in recent weeks, also headed lower. Copper prices have dropped 5.5 per cent over the past five trading days to $8,120, after hitting an all-time peak of $8,800 last week. Gold, regarded as a safe haven by investors, is down 2.9 per cent over that period but closed up at $693 an ounce yesterday.

The US consumer price index jumped by 0.6 per cent in April, far more than expected. The news sent Wall Street stocks crashing by almost 2 per cent, amid new fears the US Federal Reserve will raise interest rates more aggressively to dampen down inflation.

According to the US Labour Department, the core rate of inflation, stripped of volatile food and energy costs, climbed only 0.3 per cent. But even that represents a rate of inflation well above the Fed chairman Ben Bernanke's assumed target of 2 per cent to 2.5 per cent.

The Dow - which a week ago was threatening to breach its all-time high of early 2000 - tumbled by 214.3 points, its worst one-day fall in three years, to close at 11,205.6. Commodity prices fell back too, as markets anticipated a slowing US economy in the months ahead. Bonds also suffered a sell-off, pushing the yield on the benchmark 10-year Treasury note up by 7 basis points to 5.15 per cent at the close.

The only beneficiary was the dollar, which strengthened slightly on the prospect of more rate increases by the Fed after much speculation that last week's 0.25 percentage point boost in the Fed funds rate to 5 per cent would be the last of 16 consecutive such moves by the central bank.

But these hopes are fading fast. The worrying inflation figures reflect an economy that grew at a near 5 per cent pace in the first quarter. Wages are also growing more rapidly.

The likelihood is of at least one more 25-basis-point rate increase when the policymaking Federal Open Market Committee (FOMC) meets in June.

In London the Bank of England was split three ways over its decision to keep interest rates on hold earlier this month, the first time it has divided in this way since August 1998, minutes of the meeting showed yesterday.

Six members of the Monetary Policy Committee voted in favour of keeping rates at 4.5 per cent. David Walton unexpectedly broke ranks to call for a quarter-point increase, the first time a member had voted for a rise since May last year. Stephen Nickell backed a quarter-point cut for the sixth month running, but he is leaving the MPC and will be replaced by the academic David Blanchflower next month.

Mr Walton argued that the "balance of risks to inflation had shifted a little too much to the upside for comfort", citing higher energy and asset prices and rapid money growth. Other members of the MPC were also worried that inflation expectations were rising as a result of higher commodity prices.

The Bank warned last week it stood ready to take action to quell inflationary pressures as its latest forecasts implied the need for a rise in interest rates in the coming months. The quarterly inflation report showed inflation would exceed the Bank's 2 per cent target for the whole of the next three years if interest rates stayed at 4.5 per cent.

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