Friday, 16 November 2007

Inflation soars in US and euro zone, more calls for RMB revaluation

Inflation in the US accelerated in October. Reuters reports:

The Consumer Price Index, the most broadly used gauge of inflation, rose 0.3 percent in October for a second straight month as energy prices posted their biggest rise since May.

But core prices, which strip out volatile energy and food costs, rose a more modest 0.2 percent in October. Both the overall and core reading were in line with financial market expectations.

The muted increased in core prices should keep Fed inflation worries at bay for the time being, especially with other data showing more signs of a slowing economy.

After the data, markets were betting the likelihood of a Fed rate cut at the group's December meeting was 90 percent, up from 72 percent late on Wednesday...

A separate Labor Department report showed new applications for U.S. jobless aid rose more than expected to a seasonally adjusted 339,000 last week, and the more-reliable four-week moving average held steady at a 6-month high.

Initial claims for state unemployment insurance benefits rose by 20,000 from an upwardly adjusted 319,000 the prior week.

Reports from the New York and Philadelphia Federal Reserve banks also suggested the economy was softening.

In contrast, the ECB does not have the luxury of focusing on the core, so yesterday's report that consumer prices rose at an annual rate of 2.6 percent in the euro area will be a concern.

The contrast in monetary policy was the focus of yesterday's post by Macro Man. He says that the Federal Reserve's dual mandate balancing growth and inflation tends to make its policy more "dilutive" than policy in most other developed economies that focus on stable prices.

The implication for US dollar-peggers is that they will tend to import inflation from US monetary policy. A probable solution is to break the peg, and that "could actually see currencies like the euro and sterling decline against the buck, with dollar weakness manifesting itself most against erstwhile peggers".

FT Alphaville tells us that George Magnus, senior economic adviser at UBS, also thinks a revaluation is increasingly likely, at least for China. He points to historical precedents where a "rising power colludes to prevent proper exchange rate adjustment; internal price and asset dislocations sooner or later lead to financial excess and stress; and finally, exchange rate revaluation or faster appreciation occurs".

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