FRANKFURT -- Inflation, not market turmoil, is the main worry for central banks worldwide, from the U.S. Federal Reserve to the People's Bank of China.
A string of comments in the past 24 hours has made clear central banks are not about to adopt a more dovish monetary policy stance to alleviate a squeeze on credit markets which is pushing up the cost of borrowing.
"Central banks have taken a non-interventionist stance to recent market volatility. There's no scope for a bail-out," said Lena Komileva, G7 market economist at brokerage Tullett Prebon.
"This reflects a core shared opinion that recent volatility represents a long overdue repricing of credit risk premia to reduce excessive risk taking."
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The U.S. Fed led the pack this week when it said on Tuesday that although downside risks had increased, moderate growth was likely to continue and its "predominant policy concern remains the risk that inflation will fail to moderate as expected".
The Reserve Bank of Australia followed on Wednesday by raising interest rates to a 10-year high of 6.5 percent, and the People's Bank of China warning that inflation risks were trending higher.
In addition, the Bank of England's inflation report on Wednesday showed further interest rate tightening would be needed to bring inflation closer to its 2 percent target. BoE Governor Mervyn King said the rise in credit costs was a "welcome development".
Last week the European Central Bank had set the tone for business as usual when President Jean-Claude Trichet signalled the bank would probably raise rates in September, condemned inflation as a dangerous "drug" and described credit cost moves as a "normalisation".
Even in Japan, where the GDP deflator measure of inflation is seen flat in 2007/08, the government has said prices will rise. Bank of Japan Governor Toshihiko Fukui warned on Monday that too slow a pace of rate rises could cause problems.
Trouble in the U.S. subprime mortgage market has taken a serious toll on credit and equity markets worldwide. Earlier on Wednesday, global stock markets were down more than 5 percent from their 2007 peak and corporate credit spreads, a measure of borrowing costs, had widened by over 110 basis points since the start of the lending squeeze.
However, confidence that markets and the world economy an ride through the upheaval was buoyed by news late Wednesday that investment grade borrowers were starting to return to markets in the United States. [ID:nN08326891]
DIFFERENT TO 2000
The situation also is different from 2000-2002 when the bursting of the dotcom bubble prompted the U.S. Fed in particular to slash interest rates to cushion the fall.
Global growth is forecast to remain strong, with the International Monetary Fund for example forecasting two weeks ago that the world economy would expand by 5.2 percent this year and next — faster than it expected before the market turmoil.
Strong global growth means central banks face a wide range of inflation pressures, from rising oil and commodity prices to local shortages of skilled labour.
"Compared to the start of this decade, there's a sense that central banks are less prepared to act pre-emptively (to market trouble), said Komileva.
"The global economic cycle is a lot more integrated and the Fed, ECB and BoE are all facing tight capacity constraints in the global economy as well as varying degrees of tightness in their domestic economy."
It is not just an issue for developed economies. The PBOC pointed to spill-over effects from rising pork and egg prices as one factor behind June's 33-month high in consumer price inflation.
However, the ructions in credit markets are still at an early stage. Dodgy loans that have already claimed victims among U.S. and German finance houses may claim more, and central banks have left enough scope to change course if higher borrowing costs start to stifle business investment or consumer spending.
The Fed said downside risks to growth had increased in the wake of market turbulence, and the ECB's Trichet reminded investors to show sangfroid.
"There's the potential for more bodies to float to the surface in the next few weeks and months," said Ken Wattret, chief euro-zone market economist at the bank BNP Paribas.
"There's a bigger issue of ongoing adjustment in the U.S. housing market, what that means for growth and consumer behaviour. We're not anywhere near the end of that process and that'll be more important for Fed policy than fall out from financial markets," he said.
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