A Triple Threat

April 15, 2008

Economic news headlines these days are much more often worrisome than reassuring. Today’s main front-page story in the Financial Times captures two dangers in a seven-word headline: “Wachovia warns on U.S. Outlook after loss.” Global financial market remain stressed, and revelations of new asset losses by major financial institutions will continue past the trough in the U.S. housing market. More analysts are forecasting a U.S. recession in 2008 than not, even though some indicators, like the Empire State manufacturing index out today, will still beat expectations. According to the FT article, Wachovia has revised its U.S. outlook to show a more rapid detioration. Another lead article in the FT today touches on a third threat, elevated oil prices that could be strained further as curtailed production in Russia contains supply. So there you have it. Every day is likely to bring some disturbing news on the financial system, U.S. economy or global inflation. Often, all three problems will make the news.

Today’s dominant issue has been inflation. New Zealand reported a 3.4% rise in consumer prices since 3Q06, most since 3Q06, and a 1.1% advance in non-tradable consumer prices between the fourth quarter of 2007 and first quarter of this year. Italy’s harmonized index of consumer prices was confirmed to have jumped 1.6% in March. The 12-month pace in Italy rose to 3.6% from 3.1% and to 2.5% from 2.1% on core inflation. Food and transportation costs went up by 5.5% and 5.8% from March 2007. Core French CPI of 2.1% in the year to March sounds tame enough, except that the pace has not been so high since September 2002. The energy and food components of the index climbed 12.7% and 5.3% from March 2007. Britain served up a lower-than-expected 2.5% CPI in the year to March, same as in February, because of a 5.3% drop in clothing mitigated outsized advances of 7.0% in transportation and 5.5% in food. U.S. finished producer prices rose 1.1% m/m, almost double expectations, and non-energy and food producer price inflation advanced to 2.7% from 2.0% at the end of 2007. Between March 2007 and March 2008, producer prices for crude and intermediate goods soared 31.4% and 10.5%, so there is considerable pent-up cost strain high up in the producer price food chain. When inflation is worsening all over, currencies associated with relatively high inflation — both recently and historically — become vulnerable. Such is doubly true if the top priority of monetary policy is not inflation reduction. The triple threat of unresolved financial market strains, a weak U.S. economy, and rising inflation poses special problems for the dollar, and a falling dollar will in turn feed back into that trio of problems.



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