With all the anti-inflation talk from central banks, you will need eagle eyes to spot the true hawks. A look at underlying economic trends could help.
The latest inflation figures for the euro area should at least boost the European Central Bank's near-term determination to raise rates. From Bloomberg yesterday:
European inflation accelerated to the highest in 16 years last month as food and energy costs soared, intensifying what finance ministers from the world's richest nations said is becoming a "more complicated" dilemma.
The inflation rate in the euro area rose to 3.7 percent, the highest since June 1992, from 3.3 percent in April, the European Union's statistics office in Luxembourg said today. The rate for May is higher than the 3.6 percent estimate published on May 30.
Soaring commodity prices have pushed up costs for companies and consumers and at the same time are posing a "serious challenge" to economic growth, officials from the Group of Eight nations said yesterday after a meeting in Japan. European Central Bank President Jean-Claude Trichet this month said the ECB may raise its benchmark interest rate a quarter point in July, signaling he is setting aside concerns about the economy's expansion to combat inflation.
Some think that a rate hike from the ECB would not be enough to prevent the euro from falling against the US dollar, according to another Bloomberg report.
Currency forecasters are betting that the dollar rally is just getting started as the Federal Reserve's shift to fighting inflation makes it likely to raise interest rates more aggressively than the European Central Bank.
The currency will strengthen 2.5 percent to $1.50 per euro by year-end, according to the mean estimate of 39 firms surveyed by Bloomberg. Economists anticipate that the ECB will raise rates a quarter-percentage point by September and then cut borrowing costs by yearend. Fed Chairman Ben S. Bernanke, who said he's "attentive" to the U.S. currency, will boost rates three-quarters of a percentage point by the end of the third quarter of 2009, according to data compiled by Bloomberg.
Some, though, have doubts.
Dollar bulls are still in the minority, in part because ECB President Jean-Claude Trichet has also said inflation is a concern and the ECB rate is double the Fed's.
UBS AG, the second-biggest currency trader, last week cut its one- and three-month dollar forecasts against the euro to $1.60 and $1.53, from estimates of $1.50 and $1.47, respectively. Citigroup Global Markets Inc. reversed its bet on dollar gains, expecting the currency to fall to $1.63 within two months.
And while recent US economic indicators had generally turned out better than expected, yesterday's data reminds us that the economy remains weak.
Manufacturing in the New York region shrank more than forecast in June as customers reduced orders because of the slowdown in consumer spending and business investment.
The Federal Reserve Bank of New York's general economic index dropped to minus 8.7 from minus 3.2 a month earlier, the bank said today. Readings less than zero signal contraction...
Another report showed confidence among homebuilders unexpectedly dropped this month, signaling the housing slump may worsen. The National Association of Home Builders/Wells Fargo sentiment index fell to 18, matching a record low, from 19 in May, the Washington-based group said. Readings under 50 mean most respondents view conditions as poor.
Still, there were also signs that maybe a rate hike by the Fed wouldn't be inappropriate.
The New York Fed's...report showed raw-material costs continue to hamper business. The index of prices paid eased to 66.3 from a record 69.6. The gauge of prices received increased to 26.7, the highest since January 27.4, from 15.2...
Companies were more upbeat about their prospects. The index measuring the outlook for six months from now increased to 32.2, the highest this year, from 23.9 in May. Area factories were optimistic the slump in orders and sales wouldn't persist.
However, John Hussman thinks that the Fed is in no position to hike rates as growth concerns will soon overcome inflation concerns again.
... The Fed is on the fast track to destroying its own credibility. In my view, no sooner will all of this “tough love” leave the lips of Fed governors than the Fed will be forced to announce some novel emergency “liquidity facility” to address a fresh round of credit concerns...
Most likely, the surge in food and energy prices will diminish by the end of the summer as the result of two factors. First, it is typical for commodity prices to “hang on” early into a recession and then dive as employment losses build. Whether or not we have seen the peak of the recent vertical push, the evidence of an early recession is already in from the standpoint of anything that has provided useful warning...
Second, as mortgage foreclosures and writeoffs predictably increase in the coming quarters, we are likely to observe a fresh demand for Treasury bonds as a safe-haven because of their lack of default risk. That is likely to place downward pressure on monetary velocity, which will act as a major brake on inflation...
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