Markets shiver after Bernanke coughs

Global markets suffered another turbulent day on continuing worries about higher inflation, slowing global growth and rising interest rates.

The FTSE 100 index of leading shares lost 143.4 points to 5562.9, the biggest one-day fall since May 17, despite the Bank of England leaving UK rates steady at 4.5% as expected. Falling metals and crude oil prices - the latter influenced by the death of the Al Qaeda leader in Iraq, Abu Musab al-Zarqawi - left miners and oil companies nursing the biggest losses.

From Asia to America investors took fright, with Japan's Nikkei recording its largest daily loss in a year and falling 3% to below 15,000 by the time London opened yesterday. An early trigger for the selling was news that South Korea had unexpectedly raised its interest rates by 0.25%, which prompted concern that Japan could follow suit.

Wall Street was heading for a fifth day of decline as the UK market closed, while France's CAC 40 and Germany's DAX lost nearly 3% as the European Central Bank hiked the cost of money by a quarter point to a three-year high of 2.75%.

Analysts said comments by US Federal Reserve chairman Ben Bernanke on Monday hinting at higher US interest rates to combat rising inflation had unnerved investors. But the expectation the Fed would decide on a move at the end of this month supported the dollar, which hit a one-month high against the pound and the euro and a nearly two-month high against the yen.

"It's pretty miserable stuff in the markets," said Henk Potts, investment manager at Barclays Stockbrokers. "The falls follow on from Bernanke's remarks. He's now the most important figure in world markets and he painted a pretty bleak short-term picture of the US economy.

"With global growth slowing, companies will not be making as much money, and investors have decided they are therefore not going to pay as much for the shares."

Tom Elliott, a strategist at JP Morgan Asset Management said volatility would continue for the short term. "The markets are taking risk off the table. Normally with company profits still growing and balance sheets strong, investors would have shrugged off Bernanke's comments, but the situation is jittery out there."

But he added, "This is not the same as the 2000 dotcom boom when valuations were at silly levels."

Yesterday's move by the ECB brings rates in Europe closer to British levels since the Bank of England chose yesterday to leave its rates unchanged for the 10th month running. Many City pundits, though, think rates here may rise later in the year if inflationary pressures increase.

The ECB's move was the third such rise since last December. It had left rates at 2% for the previous two and a half years in an attempt to breathe life into the economies of the zone, particularly Germany.

But amid increasing signs that a solid recovery is taking hold in Germany and with high oil prices keeping inflation above its 2% ceiling, the central bank has made it clear it will tighten policy further.

ECB president Jean-Claude Trichet said that interest rates were still low and the ECB remained concerned about rising inflationary pressures. "If our assumptions and scenario [for stronger growth] are confirmed then progressive withdrawal of monetary accommodation will be warranted," he said.

Speaking in Madrid, Mr Trichet conceded that hawkish elements on the ECB governing council had pressed to raise rates to 3% but said "there was an overwhelming sentiment that 25 basis points was appropriate".

The ECB said it saw inflation, which rose to 2.5% in May, averaging 2.3% this year and slightly lower next year. It also left its growth forecast for this year steady at 2.1% but cut its prediction for next year to 1.8%.

Michael Hume, economist at Lehman Brothers, said the eurozone economy faced headwinds next year from a slowing global economy, a planned rise in VAT in Germany, which could reduce consumer spending sharply, and a rising euro, which could crimp the exports that have been the main driver behind the recovery. "We think the ECB will raise rates to 3% at its August 31 meeting but will have trouble raising them beyond there," he said.

Most analysts, though, expect the ECB to raise rates to 3.25% or even 3.5% by the end of the year.

By contrast, the Bank of England left UK rates on hold, having cut them in August. Until recently many analysts thought the next move could be down in response to rising unemployment and sluggish consumer spending. But in recent months robust growth data and renewed strength in the housing market have led to speculation that the MPC may be tempted to raise interest rates this year. Economic data could be distorted over the next month or two by changes in consumer spending patterns during the World Cup and so most economists think the MPC will leave rates on hold until it can get a clearer picture of the underlying health of the economy.