special reports

US Federal Reserve Faces Difficult Task, What does it Mean for Financial Markets?

Monday, 25 February 2008 16:42:28 GMT  |  David Rodriguez, Currency Analyst

The past week has highlighted the US central bank's increasing monetary policy dilemma. On the one hand, the economy is flirting with recession - hard pressed by the downturn in the housing market, instability in the financial sector, falling asset prices, and higher energy and food prices. On the other hand, inflationary pressures are growing - something confirmed by the consumer price data for January, which saw annual core inflation rise to 2.5%. There is, moreover, a risk of a further increase in inflation in the short term. Meanwhile, commodity prices have risen sharply in recent weeks, and oil has again breached the magical $100 a barrel mark.

Written by Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank

Weekly Bank Research Center 02-25-08

 

Higher US Inflation, Not Stagflation

Stephen Roach, Head Economist, Morgan Stanley

Fears of stagflation — a period of high and rising inflation, low productivity gains, and low earnings growth — are stalking financial markets. Small wonder: Signs that recession has begun are multiplying; that’s been part of our script for some time. But the rising inflation part has not: After declining for much of last year, inflation by any measure is rising again. Headline and core inflation measured by the CPI have rebounded in January to one-year highs of 4.3% and 2.5% respectively. Is it time to break out the bell-bottoms and disco shoes, as my colleague Joachim Fels insists, and usher in a period of economic misery like the stagflationary one we suffered through in the 1970s?

 

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Fed Caught on the Horns of High Inflation and Low Growth

Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank

The past week has highlighted the US central bank's increasing monetary policy dilemma. On the one hand, the economy is flirting with recession - hard pressed by the downturn in the housing market, instability in the financial sector, falling asset prices, and higher energy and food prices. On the other hand, inflationary pressures are growing - something con-firmed by the consumer price data for January, which saw annual core inflation rise to 2.5%. There is, moreover, a risk of a further increase in inflation in the short term. Meanwhile, commodity prices have risen sharply in recent weeks, and oil has again breached the magical $100 a barrel mark.

 

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Stagflation Geeks Are Betting On Higher Commodity Prices

E. Silvia, Ph.D. Chief Economist, Wachovia

The one area where stagflation theorists are scoring points is commodity prices. Oil did break $100 a barrel this week and iron ore producers are attempting to push through massive price hikes to steel producers. The strength in commodity prices is feeding through to the consumer price index, which rose 0.4 percent in January. The increase largely reflects higher prices for food and energy. Grocery store prices increased 0.9 percent in January and are up 5.8 percent over the past year. Gasoline prices rose 1.2 percent in January and are up 34.5 percent over the past year. Even after excluding food and energy items, inflation rose more than expected in January, climbing 0.3 percent, and is up more than the Fed would like on a year-to-year basis, up 2.5 percent. The most recent increase, however, may be a bit overstated.

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Canadian Inflation: Not Quite the Same Issue

Steve Chan, Economist, TD Bank Financial Group

Unlike in the U.S., the Canadian annual CPI rate actually cooled in January to 2.2% from 2.4% in the prior month, as the GST cut at the start of the year chopped an estimated 0.5 percentage points from the overall index. Core CPI, the Bank’s preferred inflation measure and which ignores the impact of indirect tax changes, also fell further from 1.5% y/y in December to 1.4% y/y in January –its lowest since July 2005. Clearly, the mighty loonie is weighing heavily on inflation, keeping it well below U.S. levels. Going forward, the elevated loonie will continue to spur Canadian retailers to remain competitive. This, along with favourable year-ago comparisons in the next few months is why both we and the Bank of Canada expect to see inflation soften further by mid-2008.

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Strong Economic Data Lifts Euro and Pound

Trevor Williams, Chief Economist at Lloyds TSB Financial Markets

The euro strengthened again this week, by 1% against the US dollar and by 0.7% against the pound, as perceptions grew that CPI inflation may be come more worrisome for the ECB, while the Fed and the Bank of England are still more fixated on slower GDP growth. But sterling appreciated against the US dollar, recovering from earlier lows, due to January’s strong retail sales figures, published Thursday, ending the week at 1.9660.

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