Stocks fall modestly as China lifts rates

LONDON (AP) -- Stocks fell modestly Tuesday after China's central bank raised interest rates for the second time in just over a month in a bid to dampen high inflation.

In a widely expected move, the People's Bank of China announced Tuesday on its website that the benchmark 1-year deposit rate would rise by a quarter percentage point to 3 percent and the 1-year lending rate would increase by the same amount to 6.06 percent.

"The announcement may cause jitters about the impact tightening will have on Chinese growth but these should not be overplayed," said Mark Williams, senior China economist at Capital Economics. "The latest increases are in line with the gradual policy tightening that has been underway over the last few months and will not do much to slow growth."

Stock markets took a small knock on the news, a day after many of the world's major indexes closed at their highest levels since the summer of 2008, before the collapse of Lehman Brothers set off the biggest bear market since World War II.

In Europe, the FTSE 100 index of leading British shares was down 0.3 percent at 6,035 while Germany's DAX rose 0.1 percent to 7,293. The CAC-40 in Paris was 0.1 percent higher at 4,087. All three had been trading higher before news of the Chinese hike filtered through.

Wall Street futures were still modestly higher - Dow futures were up 15 points at 12,123 while the broader Standard & Poor's 500 futures rose around a point to 1,317.

China's rate hike came amid mounting speculation that the European Central Bank and the Bank of England will lift borrowing costs earlier than many in the markets had earlier anticipated as inflation has spiked above target levels.

Though the ECB has had to contend with a debt crisis that has at different times threatened the existence of the euro currency itself, there are growing indications that rate-setters are getting nervous about consumer price inflation running at 2.4 percent, above the bank's mandate of keeping it "close to but below" 2 percent.

Late Monday, Yves Mersch, Luxembourg's top central banker and a member of the ECB's rate-setting governing council, said interest rates may have to rise if the current energy-related spike in inflation is passed through to wage demands.

Coming on top of comments from Spain's ECB member Jose Manuel Gonzalez-Paramo that rates would need to rise if inflation does not ease back towards target by the end of the year, the euro has pushed higher, trading 0.4 percent higher on the day at $1.3614.

Predictions of higher interest rates support the euro against the dollar at the moment because the U.S. Federal Reserve is not expected to alter its super-loose monetary policy any time soon, partly because it has a dual mandate of looking at employment levels as well as inflation.

The euro's main pillar of support so far this year has rested on growing optimism that the EU is finally getting a handle on the debt crisis that has already seen Greece and Ireland bailed out.

Some of that optimism was dented last week when a meeting of EU leaders in Brussels failed to deliver anything concrete.

Though a "comprehensive solution" was not expected to have been announced, the failure of leaders to provide a road map to a wide-ranging solution as soon as the next leaders' summit in March disappointed many investors.

"This is currently looking less likely," said Jane Foley, senior currency strategist at Rabobank International. "Demands from Germany on greater economic cooperation on tax, wage and pension policies suggest a very complicated agenda is now on the table."

Meanwhile, the euro's gains against the British pound have been capped by growing market chatter that the Bank of England will start raising interest rates even sooner, especially after stronger than anticipated retail sales and housing data.

Particularly strong was the news from the British Retail Consortium that retail sales in Britain rose by 2.3 percent in January from the year before on a like-for-like basis, which strips out new stores and additional space.

Though an interest rate increase on Thursday from the current record low of 0.5 percent is not anticipated, the fact that it is being discussed has given the pound an edge, particularly against the dollar - the markets are pricing in a near one in four chance that the Bank will raise interest rates by a quarter of a percentage point.

By mid morning London time, the pound was trading around 0.3 percent higher at $1.6140.

In Asia, China's rate hike came after the markets had closed. Investors will be interested to see how Shanghai's stock markets trade Wednesday when they reopen following the Lunar New Year holidays.

Earlier, the Nikkei 225 rose 0.4 percent to close at 10,635.98, a day after closing at a nine-month high, while Australia's S&P/ASX 200 added 0.5 percent to 4,890.40. Hong Kong's Hang Seng index, meanwhile, slipped 0.3 percent to 23,484.30 and South Korea's Kospi ended down 0.6 percent at 2,069.70.

Oil prices meanwhile fell as concerns over Egypt's political crisis have waned somewhat. Benchmark crude for March delivery was down a further 73 cents at $86.75 a barrel in electronic trading on the New York Mercantile Exchange.