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Sinking euro and rising dollar turn commodities retreat into a rout
05/05/2011 3:46 pm EST
The drop in the euro is a result of the European Central Bank’s decision not to raise interest rates at today’s meeting but instead to instead wait until at least June.
A delay until June shouldn’t have come as a surprise to anyone since I think bank President Jean-Claude Trichet signaled that June was the likely next stop on the interest rate train when the European Central Bank raised its benchmark interest rate to 1.25% on April 7.
That was the first interest rate increase from the European Central Bank since 2008. And the markets saw it as the first of a series of increases to fight inflation that hit 2.8% in April, well above the bank’s target of close to but below 2%.
On that conviction, markets bid up the euro against the U.S. dollar. The Federal Reserve seems unlikely to raise U.S. interest rates until late in 2011 at the earliest and that meant euro interest rates would be climbing while U.S. rates were sitting still for six months or more. And that increased the attractiveness of the euro against the dollar.
Today’s lack of action by the European Central Bank disappointed not only those who had read the bank’s April move as a promise of another increase in May, but also worried those who are counting on the bank to move strongly against inflation even if with a delay. In today’s statement Trichet didn’t use the phrase “strong vigilance” that has come to be the bank’s signal of an impending rate increase. Instead he said only that the bank will monitor inflation risks “very closely.” Some investors have concluded from that the bank doesn’t intend to raise rates in June either but will instead wait for July.
That worries the financial markets since it might indicate that the bank is so concerned about the debt crisis in Greece, Ireland, and Portugal that it is willing to tolerate more inflation in order not to further stress those economies. With no end to the economic difficulties in sight that possibility suggests that the European Central Bank might be less than its usual inflation-fighting self for the foreseeable future.
I don’t know how the central bank disproves that worry except by raising interest rates in June or July. Until then, the euro is going to have quite a few days like today. Which, of course, would be good for the dollar and not so good for commodities.
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