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Saturday, 28 June 2008

Prepare for global financial storm, warns British bank

Barclays says Fed has unleashed an inflation shock by not raising rates, and that there will be a deep recession over next three years

BARCLAYS Capital has advised clients to batten down the hatches for a worldwide financial storm, warning that the United States Federal Reserve has allowed the inflation genie out of the bottle and let its credibility fall 'below zero'. 'We're in a nasty environment,' Mr Tim Bond, the British bank's chief equity strategist, was quoted as saying in a report by the Telegraph yesterday.

'There is an inflation shock under way. This is going to be very negative for financial assets. We are going into tortoise mode and are retreating into our shell. Investors will do well if they can preserve their wealth.'

Barclays Capital said in its closely watched Global Outlook that US inflation would hit 5.5 per cent by August, and the Fed would have to raise interest rates six times by the end of next year to prevent a wage spiral, the paper reported.

Mr Bond was quoted as saying: 'This is the first test for central banks in 30 years and they have fluffed it. They have zero credibility.'

The Fed on Wednesday halted its run of aggressive interest rate cuts, holding rates steady at 2 per cent as it warned of inflation risks.

The Telegraph said the grim verdict on the Fed not raising rates was underscored by the markets on Thursday as the US dollar fell against the euro, helping to propel oil past US$140 a barrel.

The Barclays team was not the only voice warning of inflation. A former top Fed official said on Thursday that the central bank must quickly raise interest rates to stem inflation, or do lasting harm to the US economy if it fails to act.

Mr William Poole, the former St Louis Federal Reserve Bank president and noted anti-inflation hawk, said soaring energy prices had delivered a severe supply shock to the US economy that has impaired its productive capacity.

US carmakers are idling factories building sport utility vehicles that have become unaffordable with petrol at US$4 a gallon, while the housing downturn had sidelined a large chunk of the construction industry's capacity.

Mr Poole said in an interview with Reuters on Thursday: 'The longer they delay, the greater the risk it will get into inflation expectations and wages. 'A lot of people take comfort from the fact that inflation has not got into wages or core. But if you wait (for it) to get there, it is already too late,' he added.

Barclays' Mr Bond predicted that there would be a deep global recession over the next three years as policymakers try to get inflation back in the box. The bank also said the full damage from the global banking crisis would take another year to unfold.

Mr Rob McAdie, Barclays' credit strategist, was quoted by the Telegraph as saying: 'The core issues have not been addressed. We're still in a very large deleveraging cycle and we're seeing losses continue to mount. 'We think smaller banks will struggle to raise capital. We're very bearish - in the long term - on high-yield debt. The default rate will reach 8 per cent to 9 per cent next year.'

He said investors had taken their eye off the slow-motion disaster engulfing the US bond insurers, which together guarantee US$170 billion of structured credit and US$1 trillion of US municipal bonds.

The two leaders, MBIA and Ambac, were stripped of their top credit ratings by Moody's Investors Service last week. Further downgrades could set off a fresh wave of bank troubles, said Barclays.

Some bank analysts disagreed with the view that inflation is the chief danger, said the Telegraph. Mr Bernard Connolly, global strategist at Banque AIG, told the paper that it would be madness to throw millions out of work by raising interest rates to fight inflation. Real wages are being squeezed by oil, come what may and it may be healthier for society to let it happen gently, he told the Telegraph.

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