NEW YORK, March 26: Is inflation back? Many on Wall Street think so, and amid a harsher tone from the Federal Reserve, investors have been scurrying for cover, dragging stocks lower for a third consecutive week. In the abbreviated trading week to Thursday, the Dow Jones Industrial Average tumbled 1.75 per cent to 10,442.87 while the broad-market Standard and Poor’s 500 slid 1.53 per cent to 1,171.42. The Nasdaq composite shed 0.83 per cent to finish the week at 1,991.06. If Wall Street had been looking for comforting words from the Federal Reserve, it got the opposite. The central bank on Wednesday pushed up interest rates by an expected 0.25 percentage point to bring the base rate to 2.74 per cent. But it added a new twist to its monetary policy statement, warning of looming inflation risks — a hint that interest rates could go up more than earlier believed.

The Fed’s warning pushed an already jittery Wall Street into further turmoil as investors retrenched amid fears of higher interest rates, surging energy costs and decelerating corporate profits.

If inflation continues to creep higher — as we expect — the Fed will feel compelled to do what it takes to push growth below potential and curb the inflation, said Ethan Harris, economist at Lehman Brothers.

As a result, he said, Our forecast assumes that GDP growth slows to about three per cent in the second half of 2005.

For stocks, Harris said, this means a lot more uncertainty about negative effects.

Until a month ago financial markets were largely shrugging off the Fed, but in the last several weeks financial conditions have started to cool, he said.

David Rosenberg at Merrill Lynch said the Fed delivered a sharp jolt to financial markets.

This is by far the most hawkish press statement so far in this nine-month old tightening cycle and is eerily similar to the inflation concerns being vocalized in early 2000, Rosenberg said.

He said the statement suggests “a major transition” for the central bank and Fed chairman Alan Greenspan that shifts their focus toward taming inflation even if it means cooling off the economy.

The market’s recent selloff reflects investors’ anxiety that stronger inflation could soon force Greenspan et al to quicken their pace on boosting interest rates, added Peter Buchanan at CIBC World Markets.

Dr. Greenspan, the attendant physician, is clearly ready to administer harsher medicine if conditions warrant.

Rod Smyth, chief investment strategist at Wachovia Securities, said he believes some of the inflation fears are overblown and that market tensions may soon ease.

We think the stock market is setting up for a year similar to last year. If so, that would mean that following a strong end to 2004 and peaks this January and March, the market would drift sideways for six or seven months before breaking out above the trading range, he said.

But Smyth said he is keeping a close eye on the bond market, which is often a reliable harbinger of inflation.

We think it will be difficult for the stock market to make much progress until it becomes convicted that inflation will be contained and it sees and endpoint to the Fed’s rate hikes, Smyth said.

In 2004 the bond market correctly that consumer inflation would not be adversely affected by rising commodity prices and the Fed would remain ‘measured.’ We would regard 10-year Treasury yields rising decisively above 5.0 per cent as an inflation warning signal.

Bond prices took a hit from the Fed, although their losses were contained.

The yield on the 10-year US Treasury bond rose to 4.610 per cent from 4.511 Per cent a week earlier, while that on the 30-year bond climbed to 4.891 per cent from 4.811 per cent. Bond yields and prices move in opposite directions.—AFP