Inflation worries

illustration figure

(06.04.2011) Increasing inflation is worrying central banks globally. As a response to inflation pressures both ECB and BoE are expected to raise interest rates this year.

By Camilla Viland, Analyst at DNB Markets

According to the FOMC minutes, Federal Reserve is also getting increasingly worried about inflation and market start to believe they may also raise rates before year end.

The FOMC minutes
revealed that QE2 will continue as planned. The question now is what will happen after QE2 and when the US central bank will start to tighten monetary policy. There are different views regarding this in the committee. Some Federal Reserve official believed they would have to hold to an easy monetary policy course beyond this year while a few said the central bank should move to tighten conditions before year end.

The minutes also show the Fed is getting increasingly worried about inflation. However they concluded that for the most part that higher inflation due to energy and commodity price spikes would be temporary, but that they needed to keep a close eye on development in inflation expectations. The yield on US treasuries rose on concern that the concern of some members of the Fed would cause the central bank to tighten monetary policy before year end.

The European central bank is also worried about inflation and as a consequence they are expected to raise its key policy rate by 25 basis points tomorrow. Many believe this will be the first hike in a series. We are not of that opinion. Given fiscal tightening we expect growth to abate going forward. Thus we do not believe that the central bank will be able to hike more than twice before year end. The retail sales figures released yesterday may be an indication that growth already has started to slow. In February retail sales declined by 0.1 per cent. Furthermore retail sales growth in January was revised down. The annual growth rate is now only 0.1 per cent. The development going forward is also expected to be weak given both fiscal and monetary tightening, increasing inflation and low wage growth.

The British pound strengthened significantly after CIPS figures for the services industry rose from 52.6 in February to 57.1 in March. This was far stronger than expected. At current levels, the index point towards annual GDP growth of around 3 per cent. The services industry constitutes ¾ of British GDP and the index is, thus, important for Bank of England. All other equal yesterday's strong figures increase the probability of interest rate hikes from the central bank. The interest rate is expected to be left on hold this week. An interest rate hike in May seems more likely.

While both the ECB and BoE is expected to start raising rates soon, Japanese policy rates will be kept unchanged for a prolonged period. Attention on increasing interest rate differentials has weakened the yen lately. Versus the euro the currency is now trading at its weakest level in 11 month. The yen has also weakened considerably versus the dollar.

Chinese authorities have already started to tighten monetary policy. Yesterday Bank of China hiked interest rates by 25 basis points. The benchmark one year deposit rate will as from today be 3.25 per cent while the lending rate will be 6.31 per cent. The rise reflects concern over overheating in some sectors of the economy and a need to control inflation. Chinese consumer price inflation was 4.9 per cent in February and is expected to rise further. Oil and other commodity prices pull price growth up.

The rating agency, Moody's, yesterday followed S&P and Fitch and downgraded Portugal's long term bond rating one notch, to Baa1. Portugal is now in talks with EU on how to meet its immediate borrowing needs as its banks press them to seek a bridging loan until a new government can negotiate a bail out deal. Portugal is today going to try to raise up to EUR 2 billion in short term debt. They are expected to be able to raise the money, but that the interest rate will be very high.