Friday 27th June 2008

King Warns Against Silly Over-Reaction

During his testimony to the Treasury Select Committee on Thursday, the Bank of England’s Governor Mervyn King guranteed that the MPC will not “overreact” to rising inflation, arguing that there is a chance that slowing growth will bring inflation back under the target of 2%. The somewhat dovish comments continued with King stating that an attempt to bring rising inflation under control too quickly would, “lead to a deep recession and that would be silly.” The Governor compared the growing problems in the UK housing market with the inflationary pressures caused by soaring oil prices to emphasise the conundrum currently facing the BOE.

The parliamentary hearing also revealed that the majority of MPC members did consider a rate hike at their June meeting, as mixed messages emerged regarding what the future direction of rates could be. Although markets still expect the Bank to keep rates on hold in July, the hawkish comments of some MPC members including Kate Barker and Tim Besley regarding the possible negative impacts of inflation on the UK economy, confirmed that a hike was on the agenda in the short to medium term.

Over in the US, the dollar weakened significantly against both the pound and the euro in the aftermath of the Fed’s decision on Wednesday to leave rates on hold at 2%. Mirroring their counterparts in the BOE, US policy makers appear keen to maintain a degree of flexibility in their decisions depending on how resilient the economy proves to be. Data released by the Commerce Department on Thursday reported that the US economy expanded at an annual rate of 1% during the first quarter of 2008, above the 0.9% estimate and the 0.6% growth recorded in Q4 2007. The dollar finished the day down 0.6% against the pound at 1.9876 and EURUSD closed at 1.5760.

Sterling dipped against the euro closing the day at 1.2630 as traders increased the chances that the ECB will raise rates to 4.25% in July. Although President Trichet again reiterated that the market would be bullish to expect a series of hikes, he said that rising inflation in the eurozone did mean a “small increase in interest rates was possible”.

On Wall Street the S&P 500 slipped almost 3% as fears over further downgrades and writedowns resulted in a sell-off leaving the Dow Jones at its lowest level since September 2006. In London the recovery in the banking sector proved to be short lived and dragged the FTSE-100 2.6% lower at 5,518. The weakening dollar combined with news from Libya that it may cut production pushed oil above $140 a barrel for the first time yesterday with ICE August Brent closing at $139.83. Opec’s president also warned that prices could reach $150 - $170 over the summer.

Friday sees the release of a number of reports from the US including data on core personal consumption expenditure, which excludes volatile products such as food and energy. There are also monthly figures due out for May on personal spending and the total income received by individuals, which can provide a good indicator of the employment situation in the US. In the UK more data will be announced on GDP levels for Q1 2008 whilst in Germany the CPI index figures for June are released. After brushing Russia aside last night, Spain will be many people’s favourites to beat Germany on Sunday and lift their first major international trophy since 1964.

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