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US Fed may roll back rates to 5%

There are more near-term global draggers in store for the domestic stock market, as the central banks across the US, Japan and Europe are likely to further hike their benchmark interest rates.

india Updated: Jul 13, 2006 16:41 IST

There are more near-term global draggers in store for the domestic stock market, as the central banks across the US, Japan and Europe are likely to further hike their benchmark interest rates during their upcoming monetary policy meetings.

While the US Federal Reserve is expected to hike its benchmark rate once again, most likely at its next meeting on August 8, it might cut the funds rate back to 5 per cent level by mid-2007, global credit rating agency Standard and Poor's said in a latest report.

The US central bank raised its benchmark rate at its 17th consecutive Federal Open Market Committee (FOMC) meeting earlier this month to 5.25 per cent and another hike of 25 basis points could take the rate to 5.5 per cent.

Meanwhile, both the Bank of Japan and European Central Bank are also likely to announce rate hikes at their upcoming meetings, S&P said.

The BoJ is holding a two-day meeting -- today and tomorrow -- after which it might decide on a possible change in its zero-interest rate policy.

Any potential hikes in the interest rates in the US, Japan and Europe are likely to adversely affect the fund flows from foreign institutional investors in Indian equity markets, which has already suffered in a big way from the huge FII outflows over the past couple of months, said a market analyst.

The market observers said that despite absorbing bravely the impact of recent serial bomb blasts in Mumbai and the recent hike in US Fed rates, it might not be very easy for the domestic market to face further upward revision of the interest rate worldwide.

S&P said that the US economy would be slowing and inflation would begin to subside, "allowing the Fed to cut the funds rate back to 5 per cent."

The rating agency says excessive liquidity pressures, declining dollar and increasing trade gap have recently sent inflation heading for steady ascent forcing the 17th consecutive hike of 25 basis points to 5.25 per cent.

"But the tightening is no longer confined to the US. The world's central banks have all become worried about excessive liquidity, with both the Bank of Japan and European Central Bank signaling likely rate hikes at their coming meetings," says David Wyss of S&P in a monthly US Economic Forecast report for July.

"The reason for the global tightening is the fear of inflation. The inflation rate in the US, even excluding food and energy prices, has crept up to 2.4 per cent from 1.1 per cent at the end of 2003," Wyss added.

"The rise has been very gradual and slower than most of us would have expected given the strong energy prices. However, the trend is becoming clear, and the inflation rate is now above the top of the Fed's unofficial target range," he said.

However, the Fed is likely to "stay on the brakes" as the inflation is expected to continue to accelerate through this year-end.