Thursday, June 26, 2008

Navigating Through Stagflation

From RGE Monitor:

Today we will focus on how currencies are faring while central banks around the world are caught between a rock and a hard place with growth slowing and inflation ticking dangerously higher.

Given the moderate core inflation trends, recent hawkish Fed rhetoric seems aimed more at assuaging inflation expectations than signaling a series of aggressive rate hikes this year. At most, the Fed's accommodative policy stance may turn neutral this year but it seems still too soon for it to turn restrictive, considering the unresolved financial crisis and housing market distress. Across the Atlantic however, restrictive policy by the ECB looks more likely: The euro area's balance of risks is tilting towards inflation as the bigger threat to the economy than slowing growth, at least in the short-term. A wider interest rate gap between the Fed and the ECB raises the risk of a re-test of the EUR/USD's all-time high before the year is out. A weaker dollar could mean high commodity prices will stick around for the balance of the year, offsetting some of the anti-inflationary effect of ECB rate hike(s).

Meanwhile in emerging markets, attempts at fighting inflation have been limited by their pegged currencies and, as a result, haven't sufficed to turn real interest rates positive and dampen commodity demand. With emerging markets reluctant to make a large revaluation against their currency pegs, some are calling for a coordinated revaluation of developed country currencies to stem the rise of global inflation....MORE