Tuesday 24th June 2008

MPC Hawk Argues Slower Growth Will Dampen Inflation

Sterling fell against both the dollar and the euro on Monday subsequent to an interview which appeared in the morning press with Andrew Sentance, a member of the Bank of England’s monetary policy committee. Sentance argued in the interview that the combination of a weakening housing market, the credit squeeze and higher commodity prices is placing significant pressure on consumers which should slow economic growth and so, “Help to offset the upward pressure we are seeing on inflation.” Whilst not disputing the risk posed by inflation, the comparatively dovish tone of Sentance’s comments, particularly on the subject of rising pay demands, contrast with those made by Mervyn King and the Chancellor at last week’s Mansion House dinner.

Sentance’s views on slowing growth in the UK economy were supported by a report also released yesterday by Britain’s most used property website, which showed that the average asking price a home dropped 1.2% during May. On the back of these factors, EURGBP reached 0.791 in early trading before eventually closing the day down 1% at 0.789. The pound was also weak against the dollar, slipping to 1.9586 before mounting a slight recovery to end the day down 0.5% at 1.9644.

Following the release of two reports which illustrated that the eurozone may now also be suffering similar issues to those faced by the US and UK, the euro fell against the dollar closing at 1.551, down 0.6% for the day. Firstly the German Ifo business survey supported the results of last week’s ZEW index by reporting that business confidence within Germany has fallen this month to the lowest level since 2005. The index reported that the sharpest decline in confidence took place within the heavy industry and manufacturing sectors and this was reinforced by data from the eurozone’s Manufacturing Purchasers Index, which showed that the strength of the euro combined with high oil prices is taking a considerable toll on manufacturing. Despite this, markets are still expecting the ECB to raise interest rates to 4.25% next month.

Over in the US, analysts are predicting that the fed will keep rates on hold this Wednesday before utilizing a hike in August or September in order to contain upward inflationary pressures. It is becoming increasingly apparent that the cheap imports from countries such as China which placed downward pressures on prices during the past number of years are now being threatened by escalating transport costs. This decline in the competitiveness of imports could in turn allow US businesses to increase prices, adding to the inflationary challenges already facing the Fed. This point was emphasised yesterday as Saudi Arabia’s decision over the weekend to increase oil production did nothing to ease oil prices, as Brent crude finished the day one dollar higher at $135.91 a barrel.

Curiously it was the energy companies that benefit from higher oil prices who helped to negate persistent concerns in the financial sector and keep the Dow Jones unchanged on Monday. The FTSE-100 ended the day up 0.83%, with gains also driven by commodity stocks offsetting financial equities.

Today sees the release of figures on consumer confidence and housing prices in the US ahead of tomorrow’s rate announcement by the Fed.

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