INDIA AND Australia raised interest rates yesterday amid rising inflation fears as the US Federal Reserve prepared to take aggressive monetary policy action to stimulate the 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, putting 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 today expected to announce a more gradual approach to quantitative easing, unlike the “shock and awe” used during the financial crisis, with initial purchases of $500 billion.

In a research note yesterday, 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 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 $1.003.

– (Copyright The Financial Times Limited 2010)