September 14, 2014 / 9:34 AM / in 3 years

World waits for white smoke from U.S. Fed

FRANKFURT (Reuters) - The U.S. Federal Reserve may give clearer hints on when it will hike the cost of borrowing in the United States in the coming week, as struggling Europe braces for a tight vote in Scotland on whether to leave the United Kingdom.

U.S. Federal Reserve Chair Janet Yellen testifies before the House of Representatives Financial Services Committee on Capitol Hill in Washington July 16, 2014. REUTERS/Kevin Lamarque

As the U.S. economy picks up pace, its central bank is inching closer to raising interest rates, a move that will send ripples across the globe. In the euro zone, however, the European Central Bank is moving in the opposite direction in a desperate bid to rekindle growth and inflation.

The United States is shaking off the hangover from a financial crisis that hammered Europe and even knocked mighty China off its stride.

But the U.S. rebound, thanks in large part to cheap Fed money, now means Federal Reserve Chair Janet Yellen will have to decide when to pare back this support.

Further hints as to when the first U.S. rate hike in more than eight years will happen could come on Wednesday in a statement after the bank’s governors meet.

“It does seem like a done deal that it is going to increase interest rates,” said Paul Dales of economics consultancy Capital Economics.

“We are going into a new phase where the Fed is trying to bring things back to normal. It can send reverberations around the world economy.”

Choosing when to increase the cost of borrowing in the world’s biggest economy - a move expected next year - is a delicate balancing act.

Yellen and others will be trying to work out how to keep the economic recovery on a steady keel without stopping it before the effects of the upswing lead to higher wages.

By contrast, the European Central Bank recently cut the cost of borrowing to near zero and pledged to buy repackaged debt in a bid to kick-start lending to small companies.

For some, the eventual move in Washington will be good news for Europe.

“This will help to weaken the euro and a weaker euro will help countries like Ireland, Portugal and Spain to sell more to the rest of the world,” said Philip Lane, an economist at Trinity College Dublin.

But for others, the contrast underscores Europe’s weakness.

“America is so much further than Europe,” said Joerg Kraemer, chief economist of Commerzbank. “Any hope of economic improvement here has disappeared over the Summer.”

CULTURAL DIVIDE

On the same day as central bankers gather in Washington, the euro zone will give further insight into why price inflation, an important yardstick of the recovery, plumbed new lows in August.

On Thursday the ECB will also reveal how much of its first offer of four-year loans banks have taken up on condition that they lend on to businesses, as part of the central bank’s efforts to bolster the flagging economy in the 18-country bloc.

ECB President Mario Draghi says the aim is to get the ECB’s balance sheet back near its 2012 peak via new measures, meaning it is aiming to inject the thick end of 1 trillion euros into the euro zone economy.

Reuters polling shows that economists expect banks to take up 275 billion euros of the 400 billion the ECB will offer over time and that they will buy around 400 billion euros of asset-backed securities and covered bonds over the next two years under a separate scheme.

Adding to Europe’s woes, the conflict in Ukraine is making investors and companies nervous.

Despite a fragile ceasefire between Ukrainian government forces and Russian-backed rebels, the EU has introduced further sanctions against Moscow. Sanctions are hurting Russia and further signs of that will be seen next week in data such as measures of fresh capital investment - once a major driver of its economy.

The conflict has also hit business confidence in continental Europe, including industrial powerhouse Germany, which publishes the closely watched ZEW survey of investor sentiment on Sept 16.

Unlike the United States, Europe’s patchwork of nations and languages hampers efforts to coordinate economic policy, leaving much of the burden on the ECB.

Even within nations there are divisions. On Sept. 18, Scotland will vote on whether or not to stay part of the United Kingdom. Should it choose independence, it would send shockwaves around Europe.

Britain and Scotland would have to start dividing up their $2.5 trillion economy, North Sea oil and the national debt, while Prime Minister David Cameron would face calls to resign.

Scotland would also have to decide what currency to use. London has said it could not use the pound, while British banks in Edinburgh, Lloyds (LLOY.L) and RBS (RBS.L), say they would move south.

RETHINKING CHINA

In China annual growth has roughly halved since the financial crisis hit demand for its goods, and recent data has offered little to brighten the mainly gloomy global picture.

China’s central bank, like many of its global peers, has been pumping out cash to support the economy, raising the cost of living in cities such as Beijing, where a large two-bedroom flat can cost $1 million and a Starbucks coffee up to $6.

The government has been slow to implement reforms to dilute the power of big state-owned enterprises such as China Telecom to make space for smaller start-ups.

“Cutting interest rates may be possible if inflation falls further,” said Zhu Baoliang, chief economist at State Information Centre, a top government think-tank in Beijing. “It’s time to quicken reforms.”

For others, China’s slowdown is more than just a temporary phenomenon and may even require a rethink about basic principles of economics with its relentless focus on growth.

“It’s a long-term trend that we are seeing here,” said Guntram Wolff of Brussels think tank Bruegel.

“We are seeing the limits of the growth model in the developed economies.”

Additional reporting by Lidia Kelly in Moscow, Kevin Yao in Beijing and Michael Flaherty in Washington; Editing by Hugh Lawson

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