Financial markets around the world are now firmly convinced that interest rates are going to rise. In the US, Europe, Britain and other nations, the rate rises will come despite sinking or sluggish economic growth. Inflation is now the biggest concern.

The Bank of Canada signalled the new approach from central banks overnight when it didn’t cut the key official rate as widely tipped after four cuts in a row.

Vietnam raised its official rate late yesterday, Brazil, the Philippines and Indonesia also lifted official rates this month and Chile’s central bank meets tonight, our time and will probably increase rates.

In Europe, the Bank of England is struggling to contain surging inflation and slumping demand. Markets are pricing in up to two rate rises over the rest of this year, but analysts say the Bank of England won’t move because the damage to the fragile economy would be major. But there won’t be a rate cut to help ease the pain on housing and retailing.

Central banks in Sweden and Norway could move as well with inflation last month in both countries running at the highest level for five to six years.

So why the dramatic switch?

Well, for the second time in a week, Federal Reserve chairman, Ben Bernanke made it clear that there would be no more rate cuts. He said late Monday night that the US economic outlook has improved from a month ago, and central bankers will “strongly resist” any easing confidence in stable prices.

He was upbeat on the US economy, saying that “although activity during the current quarter is likely to be weak, the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so.”

But the key comments was on inflation: “The Federal Open Market Committee will strongly resist an erosion of longer-term inflation expectations, as an unanchoring of those expectations would be destabilizing for growth as well as for inflation.”

In the US, the key yield on 10 year US Government bonds reached 4.10%, the highest this year and came despite oil prices easing further to be down $US3 on the day at $US131.30 a barrel. US bond markets have priced in two rises in the federal Funds Rate to 2.5% in the US by November.

They are now around $US7 down on the all time high close reached last Friday as US and European analysts concluded that the big spike in oil prices late last week was caused by so-called “short covering” as investors scrambled to close out short positions in the commodity.

The US dollar rose, driving gold down $US23 an ounce to $US871 and copper fell. Wheat and corn rose as more problems emerged in the US summer grain crops with more bad weather across the Midwest. If that persists, food price inflation will return very quickly as an issue. Corn is already at an all time high of $US6.73 a bushell in Chicago.

We will know Friday night if he is right when the Consumer Price Index figures for May are released: the headline figure will be well above 4% (3.9% in April): they key will be the change in the so-called core figure: it was around 2.4% in April, above the Fed’s target of 1%-2% anything above that and Mr Bernanke’s witch will be further justified.

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Peter Fray
Peter Fray
Editor-in-chief of Crikey
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