Money Gets Tighter Almost Everywhere

Why rates are rising. Where they won't. Is the U.S. next?

The first shot was fired on Oct. 1 by the Bank of Canada, which boosted interest rates to cool the country's red-hot economy. Federal Reserve Chairman Alan Greenspan delivered his own October surprise a week later with a terse warning that U.S. growth was "unsustainable," a hint that the Fed was closer to raising rates than was widely assumed. But the big shock came on Oct. 9, when the German Bundesbank approved its first rate increase in five years--a move that prompted similar hikes in France, Belgium, Denmark, and the Netherlands.

A diabolical plot by central bankers to tighten credit just when the world economy is hitting full stride? Hardly. But the outbreak of interest-rate hikes may well signal a turning point in global monetary policy: After years of keeping rates relatively loose, many central banks are suddenly feeling pressure to reverse course. Their reasons vary widely, but the direction for interest rates is the same: up.

The Bank of Canada is not only trying to temper a growth rate of nearly 5%, but it also wants to bolster a currency that has been sagging as the country's trade surplus shrinks. In Europe, the Bundesbank has two headaches to cope with: Import prices and inflation are rising, and German bankers also are shouldering the burden of bringing Europe's disparate economies and interest rates into sync as the Continent moves toward a single currency in 1999.

In the U.S., Greenspan's saber rattling seemed aimed less at inflation than at a stock market that had gotten ahead of itself. "Greenspan's deep concern is that excessive optimism in the markets turns into a financial bubble," says David M. Jones, chief economist for Aubrey G. Lanston & Co. "He's afraid that if the markets keep soaring, the Fed at some point loses control."

As a result, some bearish forecasters predict that the central bank moves will feed through into higher long-term rates in the U.S. and Europe. Morgan Stanley, Dean Witter, Discover & Co.'s Stephen S. Roach sees rates at least a full percentage point higher in many countries next year as central banks try to mop up liquidity that has flowed from low rates. By easing too much, Roach believes the central banks are now in a fix. He fears these past "policy mistakes by the world's wise men could have dire consequences for the liquidity-driven asset bubbles of the late 1990s."

BUBA MISSION. Other forecasters, however, predict that any future rate hikes are apt to be minimal--certainly less than during recent business cycles. Why? Inflation stands at very low levels--1.8% in Canada, 2.2% in the U.S., and 1.9% in Germany.

Any hike, no matter how small, could be bad news for Latin America and for Asian economies on the mend from currency crises. Meanwhile, Japan is unlikely to join the rate parade. Its economy is still reeling from financial excesses of the 1980s and central bankers there have publicly ruled out any near-term rate hikes. "The domestic economy can't take it," says Richard Jerram, a Tokyo-based economist with ING Barings Securities (Japan) Ltd. "You'll force a whole load of companies into bankruptcy."

None of that is likely to deter the Bundesbank from what it sees as its mission. The Buba cited the potential inflationary pressures from a weakening Deutschemark as justification for raising a key short-term rate to 3.3% from 3%. But politics was at work too. With short-term rates in Germany and France much lower than those in Italy and Spain, policymakers need to align European rates to avoid triggering a currency crisis of their own. Indeed, after the Bundesbank's hike, the Bank of Spain slashed its key short-term rate by more than a half-point, to 5%.

The Germans may take the lead with each hike, for fear that allowing weak sisters such as Italy and Spain to cut rates too much could pump unwanted stimulus--and inflation--into the European economy. Analysts expect the Bundesbank to push short-term rates as high as 4.5% to reach equilibrium by the time the European Monetary Union takes effect.

Eventually, the U.S. could get dragged into the European rate rally. If rising German rates push the dollar too low against the mark, Greenspan & Co. would have one more reason to tighten. While the Fed's next move remains uncertain, the direction for rates in much of the rest of the world no longer is.

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