Global interest rates deflate Dow

The Dow Jones industrial average dropped almost 200 points yesterday, the worst day for the market in nearly three months, as investors grew increasingly worried about continued economic growth as central banks around the world have increased interest rates to combat inflation.

Yesterday's fall extended a dismal week in the market. After closing at a record high 13,767.32 on Monday, the Dow has fallen more than 400 points, or 3 percent.

The Dow closed at 13,266.73, down 198.94 points, or 1.5 percent. The technology-heavy Nasdaq Composite index fell 45.80 points, or 1.77 percent, to close at 2,541.38.

Kevin Cronin, chief investment officer of Putnam Investments, said Wall Street was reacting to short-term concerns, but fundamentally the world economy remains strong.

"The Dow's still up 6.75 percent for the year; it'll be up 10 to 12 percent" by year-end, Cronin said. "There is some profit taking and some adjustment in expectations as to what is going to happen with interest rates globally. It looks like they will be higher across the globe."

The slide began Tuesday morning, when Federal Reserve chairman Ben Bernanke said he expects the US economy to rebound after just a 0.6 percent growth in the first three months of the year. Investors interpreted his words as an indication that interest rates will not be lowered from the current mark of 5.25 percent, and the Dow Jones industrial average dropped 80.86 points that day.

Decisions by banks overseas con tributed to the slide in the following days. The European Central Bank raised its interest rate to 4 percent Wednesday, the highest it has been since September 2001. Bank of England kept the rate level yesterday while New Zealand raised its rate to an all-time high of 8 percent.

Major European stock markets in France and Germany experienced losses yesterday of about 1.5 percent, similar to the US drop. However, the Asian markets, such as the Japanese Nikkei 225 and Hong Kong's Hang Seng index, moved little.

Jeoff Hall, managing economist of Thomson Financial, said the market seemed to be coming back to more reasonable levels, as the record high reached June 4 did not match the realities of the overall health of the domestic and global economy.

"Typically we think of the Dow as an indication of the future value of the economy with the horizon of 6 to 12 months ahead," He said. "When we were at 13,600 and change it seemed to me that economic fundamentals just didn't justify" it.

Hall said inflation is growing at a faster rate than total economic growth, which triggered the central banks' decision to increase interest rates to prevent further instability. He said the central banks will continue to act in order to prevent inflation from getting out of hand, noting that strong domestic and global economic growth gives them no reason to lower rates and drive down the cost of borrowing to spur economic activity.

Recent government economic reports also seemed to affect investors' expectations. The US Department of Labor reported that 157,000 non farming jobs were added in May, up from 88,000 in April. Daniel LaPlante, senior vice president and portfolio manager at Citizens Bank of Massachusetts, said a strong labor market and low unemployment cannot coexist with a weak economy in the long run. He said it appeared the market seemed to believe the US economy won't weaken toward the end of this year.

"Ultimately, the stronger the economy is, the better the stock prices will do," LaPlante said. "But stock prices are to some degree determined by interest rates, and higher interest rates do tend to dampen economic activity in the long run."

Se Young Lee can be reached at vlee@globe.com.