London's FTSE 100, New York's Dow Jones industrial average and Tokyo's Nikkei index have fallen back sharply in past weeks, wiping out most of this year's gains.

What is going on?

The world's stock markets fear, probably correctly, that central banks, led by the US Federal Reserve, are about to raise interest rates further.

Alan Greenspan is determined to fight inflation

The Fed has already raised US interest rates twice this year and looks likely to do it again in the coming months. It has already warned of its adoption of a "bias to tighten", i.e. to increase rates.

The Bank of England has raised rates once this year and the markets have priced in further rises in the next six months.

Even the European Central Bank, which lowered interest rates to 2.5% in April, is making hawkish noises.

All the central banks are worried by the same thing - the growing global economic revival and the possibility that it will bring higher inflation.

The situation is particularly acute in the United States which has seen an eight-year economic boom.

So far the boom has not triggered higher inflation - but any sign of higher prices makes the Federal Reserve, and the markets, very nervous.

Interest rate woes

Why do high interest rates matter to stock markets?

High interest rates give all stock markets a headache

There are several reasons why rate hikes could reduce share prices.

First of all, they make alternative investments, which are generally less risky than shares, more attractive. If you can earn 6% interest in a bank account, why risk money for a slightly higher return on the stock market?

Secondly, in so far as the boom in share prices has been financed by people borrowing money and trading "on margin" - as does seem to have happened in the United States - the higher interest rates make it more expensive and more risky to keep borrowing to buy stocks.

Thirdly, stock market values are generally based on expectations about a company's profits in the future. Companies whose earnings are expected to soar are generally highly rated. But high interest rates reduce the value of future earnings.

This particularly affects fast-growing high-tech companies.

And finally, higher interest rates generally slow down the real economy. People find it harder to borrow money to finance purchases and companies find their expansion plans squeezed by higher interest rates on their bonds or bank lending. None of this is likely to be good for sales or profits.

Why now?

By most measures, stock markets have been over-valued for some time. Yet why are all these worries just surfacing now?

Ironically, part of the reason is to be found in the Asian crisis and the response of the world's central banks.

Since last autumn, central banks have lowered rates to stabilise the world's financial system and prevent a global crash.

In order to restore confidence, the Fed and others gave a big boost to the faltering markets and they responded by reaching record levels by the spring.

Lower interest rates also stimulated the real economy which turned out not to have been hit as hard as feared by the Asian crisis.

Indeed, lower prices, especially for oil, brought about by the crisis helped for a while to keep inflation in check.

But that effect of the Asian crisis is now wearing off.

The US central bank is determined to stop the US economy slowing down.

Mr Greenspan has made it clear that he believes part of the problem lies in the overheated US stock market.