Intense Inflation Pressure: Fed, Bank of England Have Their Hands Tied

US industrial production fell for the second consecutive month in May, falling 0.2%, following an unrevised 0.7% decline in April. This was worse than the 0.2% gain expected as utilities posted a sharp decline in output. Overall, industrial production is down 1.1% compared to a year ago. No one can deny that industrial output is contracting, but at least it hasn’t been a rapid drop.

Meanwhile, inflation data released today showed that US producer prices in May rose at their fastest rate in six months (1.4%), although core prices excluding food and energy, gained just 0.2%. Both figures are in line with expectations. Inflation is again becoming a threat to the US economy, which recently prompted anti-inflation rhetoric from Fed officials.

US Rate Hike Pushed Back From August To September?

The decline of the US dollar yesterday and today reflects that traders are scaling back their expectations of a rate hike by the Fed as early as August, on doubts that the Fed would indeed have room for that even as the economy is still under stress.

Interestingly, former St. Louis Federal Reserve President William Poole (he retired in March) said today on TV that “we should be moving sooner rather than later” with regards to the Fed raising interest rates. He said, “I don’t think you can interpret what’s happening with energy as a temporary shock.”

His words would have carried much more weight if he hadn’t just retired, but still, they could stem the dollar’s decline as traders readjust their expectations. JPMorgan Chase (JPM) and Barclays are now forecasting a rate increase in September.

Euro: Not Much Bullish Steam Either

The latest ZEW survey put out another spark from the Euro. Sentiment among German financial analysts and institutional investors plunged to its lowest level in June since December 1992 on rising oil prices and a weakening growth outlook. The data signals that economic activity in Germany  - Europe’s largest economy  - is slowing down after a surprisingly strong first quarter.

UK Inflation Worsens

The carefully crafted words in a letter prompted the sharp fall of the British pound today, and the currency’s prospects look very dim again. May UK consumer price inflation jumped 3.3% on the year (3.2% expected). This is the second time that the CPI is above 3% ever since the Bank of England gained independence in 1997 for setting interest rates. Since the increase is well above the BOE’s 2% inflation target, BOE governor King had to write a letter to Chancellor of the Exchequer Alistair Darling to explain why inflation is so high. So King wrote that inflation “is likely to remain markedly above the target until well into 2009″ and that the “path of bank rate that will be necessary to meet the 2 percent target is uncertain.”

Uncertain? Is he ruling out interest rate hikes? Given that fundamentals in the UK are deteriorating, the BOE may find it impossible to raise rates to fight the increasing inflation. The British pound has nowhere to go but down down down.

Forex Trading

The US dollar is slightly weaker against the Euro, Swiss franc and Japanese yen, but is a strong performer versus the British pound due to heavy shorting pressure on the pound.

EUR/USD bulls only managed to push up the currency pair up to 1.5555, near where expected resistance of 1.5560-70 lies, before bouncing almost 100 pips down to a low of 1.5460. USD/CHF declined to 1.0375, around where the support zone lies and then bounced back up above 1.0450. GBP/USD fell 230 pips from a high of 1.9700, and is now trading around 1.9500.

Economic Calendar For Wednesday:

UK BOE minutes 0830 GMT

Swiss ZEW survey 0900 GMT

US MBA mortgage applications 1100 GMT

Canada leading indicators 1230 GMT

Comments

[Reinko]

Hello Grace, again one of your beautiful articles.

You mention that producer prices grew 1.4%, the highest in six months. Well, this is very nice but are these month on month figures or year on year stuff?

Let me quote from your source (gracecheng dot com):

The report showed that the producer price index rose 1.4 percent in May following an unrevised 0.2 percent increase in April. The increase came in well above economists’ expectations of an increase of about 1.0 percent.

Comment: This means that it is a mom figure... (Because April was not revised...)

So yoy fun is 1.014^12 = 1.18 hence 18% year on year producer fun.

Of course core inflation without that stupid food and energy is only 0.2% so the populace will be protected against that nasty inflation. Really true...

[Jerry Dill]

This has been a problem for a while. While inflation is increasing we are seeing a recession and it is killing the dollar as we fight the inflation rather than the recession.

I think in the global scheme of things we need to look at the inflationary problem which continues to consume the American dollar.

The death of the american dollar does have one positive. It will now be better for businesses who sell goods overseas and operate in the US. Their goods look cheaper to Overseas companies with a currency that has better value, especially the euro and pound.

[icandoitdon]

'The death of the american dollar does have one positive. It will now be better for businesses who sell goods overseas and operate in the US'

sorry my friend, but this kind of snake oil has been sold for years by self-serving multinationals who can't otherwise compete (american auto manufacturers come to mind) and fat, lazy and ignorant politicians of both parties who are scared to death about bringing fiscal discipline to their constituencies who don't have a pot to piss in but do vote.

name one country that has ever become more prosperours over time by debasing it's currency...just one. you can't.

[flow5]

“I don’t think you can interpret what’s happening with energy as a temporary shock.” -- William Poole. He is exactly right.

Economic output, interest rate differentials, etc. are merely short-term influences. The $7 trillion dollar current account deficit drives the exchange rate of the U.S. dollar. icandoitdon is exactly right.

[zooey]

There will be no rate increases, Poole notwithstanding, until into 2009. The threat contained in a rate hike is the decline of the economy to the point that unemployment becomes unacceptable to the political class. So... We will have inflation, here, there and everywhere for some time until we witness the collaspe of global trading starts to threaten political stability. Not near done yet.

[toofan]

Jerry Dill:

"The death of the american dollar does have one positive. It will now be better for businesses who sell goods overseas and operate in the US."

The other benefit of the death of the USD is that the debt can now be paid in a currency of a lot less value than when it was taken - part of the reason why inflation is still being tolerated and more money is being printed. God Bless the common american and his children who will have to face the consequences of this inefficient and selfish Fed and Govt.