May 16 (Bloomberg) -- The world's most powerful central banks are telegraphing the end of interest-rate cuts, and traders already anticipate the first steps in the opposite direction.
Federal Reserve officials this week flagged inflation risks after slashing borrowing costs seven times since September and Bank of England Governor Mervyn King unveiled Britain's worst price outlook in a decade. Faster growth is vindicating European Central Bank President Jean-Claude Trichet's refusal to cut rates in response to the credit crisis.
``The central banks are taking a pause, but that could turn into a permanent end to rate cuts,'' said Thomas Mayer, co-chief economist at Deutsche Bank AG in London. ``The risk we won't see more cuts from the Fed and Bank of England has grown, and markets have pushed out expectations of ECB easing.''
The danger is that food and oil prices are rising so fast that inflation will replace costlier credit as the chief threat to the global economy. That may force the Fed to turn a deaf ear to what King labels the ``siren'' calls for rate cuts and perhaps consider raising them instead.
Fed Chairman Ben S. Bernanke, 54, and his team reduced their benchmark rate by 3.25 percentage points to 2 percent. The Bank of England has cut its main rate three times to 5 percent and Canada's central bank has moved on four occasions to 3 percent.
Now, Merrill Lynch & Co. forecasts global inflation will accelerate to 4.7 percent this year, the fastest pace since 1999, from 3.4 percent in 2007.
Tying Hands
``Inflation is constraining the hand of central banks,'' said Tim Drayson, global economist at ABN Amro Holding NV in London. ``They are starting to realize that they will have to see weaker economies to control inflation.''
Some traders are increasing their bets the Fed will reverse recent cuts later this year. Fed funds futures traded at the Chicago Board of Trade signal a 22 percent probability the Fed will raise its main rate to 2.25 percent by the Sept. 16 policy meeting, compared with 7 percent a week ago.
While U.S. consumer prices rose less than forecast in April, signs that financial markets are improving have prompted policy makers to reappraise the risks facing the economy. Bank of San Francisco President Janet Yellen said May 13 that rate cuts to date ``could lead to higher inflation expectations and an erosion of our credibility.''
Former Fed Chairman Paul Volcker warned on May 14 that ``there is some resemblance to where we are now in the inflation picture to the early 1970s,'' when central banks failed to contain a pickup in prices.
Siren Call
In the U.K., King warned on May 14 against the risk of lowering borrowing costs too much, suggesting the Fed may have overdone it. ``We did not fall prey to the sirens to cut interest rates further as some other central banks have done,'' the 60-year-old King said.
Still, his proclaimed prudence failed to stop U.K. inflation from jumping the most in six years in April as it accelerated to the government's upper limit of 3 percent. The rate on the December rate futures contract has risen 63 basis points to 5.74 percent this week, suggesting traders have abandoned bets on rate cuts this year.
Nevertheless, a further deterioration in credit markets will deal another blow to the global economy, requiring more policy action. Vincent Reinhart, a former Fed economist and now a scholar at the American Enterprise Institute in Washington, cautions against a ``premature'' end to rate cuts.
Reinhart's Warning
If credit markets deteriorate again and growth falters, ``central banks will have to roll back talk of future tightening and may even ease,'' he said.
King on May 14 said it's ``quite possible we may get the odd quarter or two of negative growth'' and further ``shocks'' could make matters worse. While Bernanke said this week that tensions in markets have eased, conditions are still ``far from normal.''
Inflation concerns in the U.S. and U.K. chime with those often sounded by Trichet and central bankers from Brazil to Taiwan since markets seized up in August. With the Middle East and Asia still driving the global economy and pushing food and oil prices higher, inflation threatens to become entrenched.
The ECB has left its rate at 4 percent since June. Data released yesterday showed the 15-nation euro economy growing faster than expected in the first quarter, while inflation held above the ECB's ceiling for an eighth month.
Risks Undiminished
Trichet, 65, said in a speech in Brussels today that ``there is no place for complacency'' amid clear inflation pressure. In an interview in Vienna, ECB Governing Council member Klaus Liebscher signaled the bank may leave rates unchanged throughout this year.
Asked if the bank could lower rates in 2008, he said, ``given the risks for price stability, I think the answer is a clear one. The risks have not diminished.''
Eonia swap contracts, a widely used market gauge of rate expectations for the euro-area, rose to 4.05 percent yesterday from around 3.2 percent in mid-March, showing traders no longer expect cuts from the ECB.
``Trichet is sitting pretty,'' said Jean-Michel Six, chief European economist at Standard & Poor's in Paris. ``He's been against the consensus in saying of the twin evils inflation is a bigger threat than a slowdown.''
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