Central banks are not so much taking away the punch bowl from the party as handing guests their coats and holding the door open for them to leave. If there were any doubts about the direction of global monetary policy, Thursday’s simultaneous rate rises from the European Central Bank and Bank of England (after Australia earlier in the week) settled them.

In the long run, this is probably positive for the markets, since some had started to fear that central banks were going soft on inflation, after the deflationary scare of 2003. Although it may well turn out that higher commodity prices serve to contract demand, instead of resulting in a cost-push price spiral, banks are not taking the risk.

In the short term, however, investors will be nervous. Some think the US economy will extend its second quarter slowdown into the second half of the year, in the face of a rapidly weakening housing market. That would require the European and Japanese economies to take up the slack, something that may not happen if interest rates rise too much.

By removing the word “vigilance” from its statement, the ECB seemed to rule out a rate rise later this month. But analysts are still expecting a further move towards the end of the year and Barclays Capital said that short sterling moved to price in a further UK rate increase in November.

Furthermore, speculative investors will worry that the cost of financing their positions is steadily rising. That worry will increase substantially if the US Federal Reserve raises rates next week.

Some commentators have long held the view that the global economy avoided crisis in the wake of the dotcom bubble only because central banks, by cutting rates so sharply, created a housing bubble (particularly in the US) to bolster consumer spending. If that view is right, then the economy may face some testing times over the next year or so.

But the bulls will argue that interest rates are only returning to “normal” levels after the crisis lows earlier this decade and that, with corporate profits and household balance sheets still strong, the odd quarter point rate increase is nothing to worry about.


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