Interest rates on way up, say investors

BOND investors, who little more than a month ago were predicting lower interest rates amid a growing risk of deflation to the global economy, now say the next move by the Federal Reserve, the European Central Bank and the Bank of England will be to increase interest rates.

“There’s been an absolute U-turn in rate expectations,” said Rajeev Demello, who manages the equivalent of $5.8 billion in euro-region bonds at Pictet & Cie, Geneva’s largest private bank. “No one expects a cut anymore.” Not after the US economy, the world’s biggest, showed annualised growth of 2.4% in the second quarter; in Japan, the number two economy, household spending had its biggest gain in almost two decades in June and in Germany, the third-largest economy, business confidence rose to a one-year high in July.

December futures contracts indicate investors who on June 13 had seen as much as a half-point cut in the benchmark federal funds rate aren’t forecasting another reduction. Fed policymakers meet this week to decide on interest rates, with all of the 78 economists polled by Bloomberg News forecasting no change. The Fed will raise rates in the second or third quarter of next year, a survey of 53 economists showed. In Europe, the yield on the three-month Euribor contract for December rose above the three-month money market rate this month, ending almost a year of rate-cut expectations. The June contract yielded 2.45% yesterday morning in Frankfurt, suggesting investors predict rising rates by the end of the first half.

Investors are betting on a British rate increase by the end of 2003. In Europe, the lowest borrowing costs since 1946, coupled with the prospect of tax cuts in countries including Germany and France, have bolstered optimism among executives and consumers.

Business confidence in Germany, Europe’s largest economy, rose to a one-year high in July and consumer confidence gained for a fifth month. Europe’s services industry, which accounts for more than half of the economy, expanded for the first time this year.

“The European Central Bank will wait for some more data first to assess the impact from the latest rate cut,” said Heinz-Joachim Neubuerger, chief financial officer of Munich-based Siemens, Germany’s largest engineering company, in an interview. “I don’t think they will change rates again this year.” The ECB said on Thursday it sees “increasing reason” to expect a recovery in the second half. Japan’s economy probably grew 0.2% in the second quarter, after expanding 0.1% in the first, a Bloomberg survey of 24 economists showed.

Rate cut expectations have also been reversed in Britain after the Bank of England cut its benchmark lending rate to a 48-year low of 3.5% on July 10. Consumers are taking advantage of low credit costs to borrow at record rates. New car sales reached a record in July and service industries expanded at the fastest pace in 14 months.

“The next move by any major central bank will be an increase,” said Marc Touati, chief economist at Natexis Banques Populaires in Paris. He expects the Fed to raise rates in October and December and the Bank of England and the ECB to follow in the first half of next year.

But some executives and economists say hopes for a quick rebound in the US and Europe may be too optimistic.