Will Rising Inflation Force Central Banks to Raise Interest Rates?

After responding to the global financial crisis by implementing a barrage of stimulus measures, it seems that demand is finally starting to pick up. Across the globe, we’re seeing news about inflation hit major headlines and become a trending topic on Twitter and Weibo, as rising commodity prices continue to put pressure on consumer prices.

Yesterday, reports revealed that consumer prices in the U.S. rose by 0.4% in January, pushing year-on-year inflation up to 1.6%. This marked the highest level in seven months!

Meanwhile, in Europe, inflationary pressures are threatening to blow up and are now knocking on the doors of the ECB and BOE. Euro zone inflation currently stands at 2.2% while for the U.K, it is at a scorching 4.0%. Take note that these are both above the target inflation bands of their respective central banks.

Year-on-year Inflation Figures

Why exactly have the markets been focusing on inflation anyway?

Remember, while rising prices do indicate growing demand, if they are not contained, it could lead to hyperinflationary environments, which could end up being disastrous for the economy. This is why central banks pay close attention to inflation and use it as one of the primary factors when deciding upon monetary policy.

In fact, central banks of emerging economies have already taken notice. Countries like China, Brazil, and India have all raised interest rates in an effort to slow down the rise of inflation that began early last year.

With emerging nations taking the lead and raising rates, is it only a matter of time before central banks from old powers like the U.S., euro zone, and the U.K. follow suit?

Some analysts believe that the ECB and BOE cannot ignore the risks of hyperinflation and will most likely act accordingly by raising interest rates later this year. Word on the economic grapevine is that both banks might raise rates by as much as 75 basis points each before the year ends.

This appears to be reflected on the charts, as the euro and pound have held steadily as of late. Despite the release of positive U.S. data, the dollar found itself struggling this past week, as a return of risk appetite boosted higher yielding assets.

Wait a second, that doesn’t make any sense Mr. Gump! Shouldn’t good U.S. data help the dollar?

In theory yes, but it seems that the markets have something else in mind.

While the Fed has upgraded its outlook on the U.S. economy, the markets don’t believe that Fed President Ben Bernanke and his buddies are as hawkish as their counterparts across the Atlantic. The market seems to be pricing in the potential rate hikes by the ECB and BOE, as well as betting that the Fed will take a more cautious and slower approach to raising rates.

With that in mind, does this mean we’re in line for a bearish dollar trend this 2011?

To be honest, I’m not quite sure. While it is hard to ignore the data showing strong inflation figures from the euro zone and U.K., I still believe that we should wait for austerity measures to fully kick in before hopping on the euro or pound bandwagons.

For the meantime, keep an ear out for any statements made by any central bankers. A slip of the tongue here or there may just reveal their hands and give us clues as to exactly how hawkish each central bank is!


  • donkeykong

    with oil getting to new highs inflation in the uk will probably go up? more than 4% and no rate hike? that makes no sense.

  • donkeykong

    with oil getting to new highs inflation in the uk will probably go up? more than 4% and no rate hike? that makes no sense.