Friday 7 January 2005

Inflation fears persist

The US non-manufacturing ISM business activity index rose 1.8 points to 63.1 in December, indicating continued expansion.

What was noteworthy, I thought, was that the price index rose to 71.4 in December from 71.0 the previous month. The price index for its manufacturing counterpart had fallen in December, but to a still-high 72. Clearly, inflation fears persist.

This is consistent with the view of the Federal Open Market Committee -- as revealed in the minutes of the 14 December meeting released on Tuesday -- that interest rates "remained below the level it most likely would need to reach to keep inflation stable". Watch for further increases in the fed funds rate throughout the year.

Of course, this leads to the next question: Would long-term interest rates follow the fed funds rate up?

If Asian central banks continue to buy US dollars at the pace that Brad Setser thinks they have been, there is little guarantee of that.

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