U.S. rate hike likely to be delayed by slow economic recovery

Investors are eyeing the U.S. as the next country to aggressively reign in their excess liquidity.  The expected rate hike, however, may be delayed as persistently high unemployment and poor business credit conditions dampen private demand.

Private Demand

A recovering economy would set the stage for potential interest rates hikes; however Bernanke noted that demand from businesses and consumers remained weak.

Although the second half of 2009 did show a 4 percent annualized rate of growth, the chairman readily admits that a significant portion of that growth was due to the progress firms made in working down unwanted inventories of unsold goods.  As the government winds down fiscal support, the economic recovery will lean more on private demand, he said. 

But the outlook for private demand continues to be hampered by high unemployment levels and deteriorating credit conditions for businesses and consumers. 

Bernanke acknowledges that bank lending continues to contract, reflecting both tightened lending standards and weak demand for credit amid uncertain economic prospects.

Unemployment, and fears stemming from the prospect of it, are also playing a role.  He notes that job openings are scarce and that 40 percent of unemployed Americans have been out of work for over 6 months. 

Slow Growth Europe and U.S.

The sentiment was echoed by Bank of England Governor Mervyn King in a statement on Tuesday.

Domestically, U.K. bank lending to businesses continues to fall.  In the euro zone -- U.K.'s main export destination -- economic recovery appears to have stalled. 

King is particularly concerned about the global economic imbalance between debtor and creditor nations. 

He stated that some countries who rely on foreign lending, namely Western nations, have reduced their reliance on such capital.  However, without a compensating pick up in external demand for their goods and services, these countries will continue to experience weak recoveries.

King also added that the countries who showed strong growth in recent quarters are those whose banking systems were relatively unscathed by the crisis. 

Although King's comments referred to the euro zone, the same conditions apply to the U.S.

The U.S. is the world's largest debtor nation and the near collapse of its financial system was the catalyst of the global financial crisis.  

Rate Hikes around the World

Australia was the first to raise its interest rate.  The country was supported by its mining boom, its trade with China, and its banks were relatively unscathed by the financial crisis.   

Although officials unexpectedly left the rate unchanged at its latest meeting, some market participants anticipate another rate hike in March.

Chinese banks also proved to be fairly resilient and some economists forecast that its Gross Domestic Product will grow 10 percent in 2010. 

Although China did not raise its interest rate yet, it began to restrict big bank lending and already raised the bank reserve requirement twice.  Some analysts expect China may raise its interest rate as early as March. 

Investors are also eyeing Canada and India to soon raise their interest rates.

Countries likely to raise rates at a slower pace than the U.S. include Japan and European nations. 

Japan's economy is extremely fragile, plagued by deflationary pressures, unemployment, and a woeful banking system. 

The euro zone economy is recovering slower than the U.S. and sovereign debt worries of peripheral members nations will slow and complicate the ECB's liquidity withdraw.