Europe wants Fed, China rate rises: G7 sources

A money-changer in the Kosovo capital Pristina adapts quickly to Europe's new currency in Pristina, January 2, 2002 displaying a handlful of euro notes along with his regular supply of U.S. dollars and German marks.

(Reuters) - The U.S. Federal Reserve should raise interest rates to stem the slide in the value of the dollar and curb global inflationary pressure, European G7 sources have told Reuters, but concede they are unlikely to get their wish.

With the euro hitting record highs against the dollar and the European Central Bank raising interest rates to combat inflation, euro zone G7 officials are getting very frustrated with U.S. policy. There is no coordination, said the senior officials from monetary and economic policy circles.

They are also frustrated by China. European G7 officials said Beijing could do more to help the world financial system by raising rates, but is constrained by domestic politics.

The absence of action in the face of a year-old credit crunch, soaring inflation and stagnating growth has left many investors fearful that the world economy could slip into its most perilous state since the Great Depression of the 1930s.

G7 officials have told Reuters there have been regular discussions over the last few weeks to assess the latest leg in the financial market upheaval that started almost a year ago and shows no sign of ending.

But there has been little in the way of a joint plan to address the problems facing the world economy as G7 deputies prepare for meetings in Japan at the end of July.

"To curb global inflation the Fed should be raising interest rates, but on the other hand they have all the problems of the financial sector to worry about, and there is unlikely to be any interest rate hike before the U.S. election," said a G7 source.

"If the Fed raises rates or at least makes clear it is going to raise rates, that would help slow the Chinese economy too and probably bring down oil prices and put a ceiling on the euro."

The euro hit a record high above $1.60 last week as investors became increasingly nervous about the U.S. financial system. It has since come off but is still at levels strong enough to cause pain to Europe's exporters.

JAPAN AGAIN

Financial markets are getting twitchy about coordinated intervention to stem the dollar's slide, but there appears to be little scope for joint action for now.

"It's just a routine meeting," said one G7 source who will attend the upcoming deputies' meeting in Japan.

It's every man for himself, said another G7 source. U.S. officials say they believe in a strong dollar but it is just talk. They know a weak dollar helps exports.

The European hope is that the Fed will raise interest rates and expectations of further tightening will be enough to prop up the dollar and take some of the pressure off the euro.

Hikes from China would help too.

"(The yuan) clearly needs to appreciate and Chinese interest rates need to rise," said the first G7 source. "If you talk to the people at the PBOC (People's Bank of China) they are very reasonable about it.

"The trouble is that the politicians are the ones in command, not the PBOC," the source added.

Social stability is considered by analysts to be the top priority of China's political elite, putting their focus on growing the economy fast in order to accommodate millions of rural poor who move to cities every year in search of jobs.

There were still 204 million Chinese in 2005 living on less than $1.25 a day, according to the World Bank. The result is a gulf in incomes that is one of the country's greatest social and political challenges.