Inflation looks bad, markets look to Fed

Yesterday's US economic news and market action proved to be interesting. Reuters reports that the inflation news was bad:

U.S. core consumer prices rose more than expected in June...

The Labor Department attributed over half of the 0.3 percent monthly advance in its core consumer price index...to the rising cost of shelter.

It was the fourth straight 0.3 percent rise in core consumer prices, which Wall Street had expected to increase by 0.2 percent. But overall consumer prices gained 0.2 percent, as expected, as energy costs declined 0.9 percent in June...

The Labor Department report demonstrated a trend of steadily rising consumer prices in recent months. Core consumer prices have advanced at an annual rate of 2.6 percent rate over 12 months, 3.2 percent in the past six months and 3.6 percent in the past three months. It was the highest six-month rate since June 1995...

Meanwhile, the Labor Department said average weekly earnings rose 0.6 percent from May to June, but average hourly earnings have fallen 0.6 percent over the past year.

But the housing market is slowing.

June housing starts fell 5.3 percent in June to a 1.850 million unit annual pace from a downwardly revised 1.953 million unit pace in May. U.S. single-family housing starts fell 6.5 percent to an annual pace of 1.486 million units, the slowest since November 2004...

The Mortgage Bankers Association said its seasonally adjusted index of mortgage application activity fell 4.6 percent.

So how is the Federal Reserve likely to respond?

Fed Chairman Ben Bernanke said at a congressional hearing that stubbornly high inflation could harm the U.S. economy, but the Fed is expecting both economic growth and inflation to moderate. He said the economy appears to be "in a period of transition" to slower rates of growth and this moderation could reduce price pressures.

And that was something that markets certainly responded to.

Bond and stock markets rallied while the dollar sold off sharply on the central bank chairman's comments.

If the Federal Reserve sounds somewhat dovish, the Bank of England has not been too hawkish either. Again from Reuters:

Interest rates seem likely to remain at 4.5 percent for some time, minutes to the Bank of England's July policy meeting suggested on Wednesday, with all seven committee members voting for no change.

But the European Central Bank still looks likely to raise rates soon, especially after the latest data on producer prices in Germany. From Bloomberg:

Producer price inflation in Germany, Europe's largest economy, rose more than economists expected last month as the cost of energy and raw materials increased.

Goods from plastics to newsprint were 6.1 percent more expensive in June than a year earlier, the Federal Statistics Office in Wiesbaden said in a statement today. Economists forecast a 5.9 percent gain, according to the median of 35 estimates in a Bloomberg News survey. From May, prices rose 0.3 percent.