US Federal Reserve Interest Rate Increase May Be Indicated This Week

(Reuters) -- The U.S. Federal Reserve may give clearer hints on when it will boost the cost of borrowing in the coming week, even as struggling Europe braces for a tight vote in Scotland on whether to leave the U.K. 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 eurozone, however, the European Central Bank is moving in the opposite direction in a desperate bid to rekindle growth and inflation.

The U.S. 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 L. Yellen will have to decide when to pare back this support.

Hints as to when the first U.S. interest-rate hike in more than eight years will happen could come Wednesday in a statement after the Federal Open Market Committee meeting.

“It does seem like a done deal that it is going to increase interest rates,” said Paul Dales of the 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 ECB 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 at Commerzbank. “Any hope of economic improvement here has disappeared over the summer.”

Cultural Divide

While U.S. central bankers gather in Washington, the eurozone will give more insight into why price inflation, an important yardstick of the recovery, plumbed new lows in August.

The ECB will also reveal Thursday 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 has said 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 ($1.3 trillion) into the eurozone economy.

Reuters polling shows economists expect banks to take up €275 billion ($356.4 billion) of the €400 billion ($518.4 billion) the ECB will offer over time and that they will buy around €400 billion 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 cease-fire between Ukrainian government forces and Russian-backed rebels, the European Union has introduced more sanctions against Moscow. Sanctions are hurting Russia, and new 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 Sept. 16.

Unlike the U.S., 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. Scotland will vote Sept. 18 on whether to remain part of the U.K. 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 Banking Group PLC (LON:LLOY) and Royal Bank of Scotland Group PLC (LON:RBS), 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 as much as $6.

The government has been slow to implement reforms to dilute the power of big state-dominated enterprises such as China Telecom Corp. Ltd. (NYSE:CHA) to make space for smaller startups.

“Cutting interest rates may be possible if inflation falls further,” said Zhu Baoliang, chief economist at the State Information Center, 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 the Brussels think tank Bruegel. “We are seeing the limits of the growth model in the developed economies.”

(Reporting by John O’Donnell; Additional reporting by Lidia Kelly in Moscow, Kevin Yao in Beijing and Michael Flaherty in Washington; Editing by Hugh Lawson)