Asian nations tighten ahead of Fed

By Kevin Brown, James Fontanella-Khan and Peter Smith

(FT) -- India and Australia raised interest rates on Tuesday amid rising inflation fears as the US Federal Reserve prepared to take aggressive monetary policy action to stimulate the stuttering US economy.

Although both countries' central banks cited domestic pressures on inflation as the main reason for the rises, the Reserve Bank of India also drew attention to fears that a new round of quantitative easing in the US and elsewhere could flood emerging markets with fresh capital inflows, putting further pressure on rising asset prices.

"While the ultra-loose monetary policy of advanced economies may benefit the global economy in the medium term, in the short term it will trigger further capital inflows into emerging market economies and put upward pressure on global commodity prices," said Duvvuri Subbarao, the central bank governor.

The Fed is on Wednesday expected to announce a more gradual approach to quantitative easing, unlike the 'shock and awe' it used during the financial crisis, with initial purchases that may amount to $500bn.

QE, or not QE? That is the question

In a research note published on Tuesday, HSBC warned that emerging markets were struggling with what it called an "impossible trinity" -- an inability to allow free flows of capital while simultaneously maintaining a grip over interest rates and exchange rates. That, the bank's economists warned, meant that "the more the west pursues quantitative easing, the more the emerging world, via capital controls, will pursue quantitative tightening".

Economists said a less aggressive approach from the Fed should moderate US dollar weakness. However, the Reserve Bank of Australia's surprise decision to lift its official interest rate by 25 basis points to 4.75 per cent lifted the Australian dollar by as much as 1.2 per cent to a record US$1.003.

The Aussie reached the same level as the US dollar for the first time in mid-October but had since retreated. It was trading at US$0.9882 before the announcement.

The Australian central bank, which had held rates since May, said the country's economy was "subject to a large expansionary shock from the high terms of trade and has relatively modest amounts of spare capacity".

The RBA has now raised rates seven times since October last year when they hit a 49-year low of 3 per cent. Australia stood alone among the developed world by narrowly avoiding technical recession during the global financial crisis, and its central bank was the first among the Group of 20 nations to begin raising rates in the aftermath of the downturn.

Economists expect both central banks to put further rate increases on hold. The RBI, which raised its repo rate -- the rate at which the central bank lends to commercial banks -- by 25 basis points to 6.25 per cent, said the likelihood of further rate actions in the immediate future would be relatively low.

"The RBI has clearly indicated for a pause in the upcoming December policy meeting," said Anubhuti Sahay, an economist at Standard Chartered. "Further rate hikes in 2011, if any, would be conditional on upside surprises in inflation."