Continued tightening by the U.S. Federal Reserve Board could lead a global slowdown, denting commodity markets and Canadian financial markets, warns BMO Nesbitt Burns in a new report.

“There is a real risk that if the Fed continues to tighten monetary policy (and the fed funds futures market suggests the odds are better than even), global economic slowdown could ensue,” BMO Nesbitt warns.

The report notes that the U.S. economy seems to be slowing, but with inflation on the rise, the Fed may yet raise rates still higher. “From the slowing economic data seen in the U.S., the Fed has gone far enough and risks, once again, the potential for overshooting its goal. Judging from past tightening cycles, interest rates may be low, but they have increased dramatically,” it explains.

BMO Nesbitt adds, “We have already seen rate hikes by the Fed, the Bank of Canada, the European Central Bank, the Reserve Bank of Australia and the People’s Bank of China. The Bank of Japan is sopping up excess reserves and soon will be raising interest rates, as will the Bank of England. The risk is that this unprecedented synchronization of monetary tightening might slow economic growth more than intended, and inflation would come down — with a lag — anyway.”

“Inflation would fall anyway, so the risk of tightening too long is not worth the cost of giving [new Fed chairman Ben] Bernanke his inflation-fighting credentials,” it says.

“The FOMC’s decision will potentially have a considerable impact on the direction of commodity markets in 2007, and therefore on the Canadian economy, the Canadian dollar, and the Canadian stock and bond markets,” it concludes.