A major development last week was that the euro surged to a three-month high against the U.S. dollar after the European Central Bank (ECB) hinted after its monthly meeting that it might raise key interest rates soon to combat inflation. Specifically, ECB President Jean-Claude Trichet said on Thursday that an interest rate hike at its April meeting was “possible” but not certain. Trichet also said that “strong vigilance” is needed to “protect price stability” — phrases that usually signal a coming interest rate hike.
Emerging economies like China, Brazil and India are fighting inflation with rate increases. Brazil’s central bank raised its key interest rate by 0.5% to 11.75% on Wednesday, and India’s central bank has been raising rates often (seven 0.25% interest rate increases) to combat inflation, even though those rate increases can slow GDP growth. Meanwhile, the U.S. Federal Reserve continues to act like an ostrich with its head in the sand, oblivious to global inflation. Unlike most other central banks, the Fed has not even hinted that it might hike key interest rates. This policy undermines the dollar, since investors want to see a real return on their cash deposits — not the current near-zero rates available for short-term deposits.
On Tuesday, Fed Chairman Ben Bernanke told the Senate Banking Committee that “inflation is stable.” Bernanke defended his policies by saying that the U.S. dollar is about as strong as it was before the big financial crisis three years ago and that any warnings of coming dollar devaluations are “way overstated.”
Apparently The Wall Street Journal disagrees, as the Journal featured an editorial on “Why the Dollar’s Reign is Near an End.” The Journal predicts that current Fed policies could spell the end of the dollar as a global reserve currency. In addition, a weak U.S. dollar fuels commodity inflation, since approximately 88% of the world’s commodities are priced in U.S. dollars. The good news, for the short-term anyway, is that a weaker U.S. dollar can also boost U.S. exports and the earnings of many multinational companies.
Higher Food, Energy Prices May Hurt Global Growth
The more the U.S. dollar decays, the faster we will see crude oil and food prices rise. On Thursday, the United Nation’s Food and Agriculture Organization (FAO) announced that its food price index rose 2.2% in February, reaching an all-time high. This is the eighth monthly rise in a row for the UN food index.
The UN also reported that global cereal supplies may tighten sharply this year, implying that food prices will rise further. These high food costs could curtail economic growth in poor countries, since consumers will be forced to spend more on food and less on other items. In fact, last week India reported that its economic growth slowed to an 8.2% annual pace last quarter, down from 8.9% in the third quarter.
In China, economic growth is also showing signs of slowing, since the Chinese purchasing managers’ index slipped to 52.2 in February, down from 52.9 in January. Although any reading above 50 signals expansion and February marked the 24th straight monthly increase in manufacturing activity, new export orders decreased for the first time since August, raising concerns that global economic growth may be slowing, especially in emerging markets where high food and energy costs have a much bigger impact.
As crude oil prices continue to rise, political pressures forced the Obama administration to issue its first deep-water drilling permit since last year’s tragic BP (NYSE: BP) oil spill. The Obama administration said it expects to issue more deep-water drilling permits in the coming weeks and months, if companies demonstrate that they can drill safely. The American Petroleum Institute argued that “this slow-moving process continues to stifle domestic production and puts thousands of jobs at risk in the Gulf and around the country.”
We’ll hear a lot more talking heads today, as the ECB’s Jean-Claude Trichet addresses reporters after a major central bank meeting. In the United States, Dallas Fed President Richard Fisher has a major speech, as does former Fed Chairman Paul Bolcker, speaking at a special bank forum. On Friday, I’ll watch closely when January business inventories, February retail sales and the March Michigan Sentiment index are all releasd.