US Fed: Upside Inflation Risks Take Center Stage, US Dollar Comes Into Focus

The FOMC is very likely to leave rates unchanged at 2 percent, as more accommodative policy is no longer needed and in fact, may actually be damaging as upside inflation risks build. Indeed, Bernanke even brought the US dollar into focus over a month after the currency tumbled to record lows versus the euro. The depreciation of the currency has been a contributor to the jump in import and consumer prices, and if the US dollar continues to remain broadly weak, Federal Reserve officials may start to harp more upon the price action, especially as inflation remains an issue globally.

Donald Kohn, Federal Reserve Vice Chairman

“…the existence of liquidity facilities at the central bank can undermine normal incentives for maintaining liquidity buffers, and the more extensive the access, the greater the degree to which market discipline will be loosened and prudential regulation will need to be tightened… one important lesson from recent developments is that we need to devote greater attention to money markets. Disruptions to those critical markets have the potential to significantly harm the financial system and the real economy.” – May 29, 2008

Richard Fisher, Federal Reserve Bank of Dallas President (Voting Member)

“If inflationary developments and, more important, inflationary expectations, continue to worsen, I would expect a change of course to occur sooner rather than later, even in the face of an anemic economic scenario…We trust that the various term credit facilities we have recently introduced are helping to restore confidence while the credit markets undertake self-corrective initiatives and lawmakers consider new regulator schemes…I see a frightful storm brewing in the form of untethered government debt.” – May 29, 2008
 
Dennis Lockhart, Federal Reserve Bank of Atlanta President (Non-Voting Member)

“Although conditions have improved on some fronts, I don't feel we can yet ‘breathe easy.’ The path of the economy is still enveloped in considerable uncertainty, and serious risks remain…My storyline looking ahead is not so severe a slowdown, but not so quick a recovery… we have a slow-growth economy poised for gradual recovery, weak but not collapsing labor markets, a slowing pace of decline of housing, more settled but still fragile financial markets, and uncomfortable levels of inflation with hints of rising inflation expectations.” – June 2, 2008

ECB: Rates on Hold at 4% This Week, But How Hawkish Will Trichet Be?

Price stability remains the name of the game in the Euro-zone, as ECB President Trichet continues to tout its importance, especially as energy and food prices skyrocket. Furthermore, with the Federal Reserve – previously one of the most dovish central banks in the world – signaling that they will not cut rates further, the ECB will face far less pressure to do the same despite instability in the financial markets. The biggest risk to the euro this week, though, is just how hawkish Trichet will be during his monthly post-rate announcement press conference on Thursday. Given the serious upside risks to inflation, the ECB President is highly unlikely to sway from his staunch stance despite signs of slowing in the Euro-zone economy.

Jean-Claude Trichet, European Central Bank President

“We are the only central bank which is actively contributing to a major structural transformation of its own economy...We are called upon to extend progressively the euro area across the European Union as a whole…We know also that price stability is a prerequisite for financial stability, a very important objective at the current juncture.” – June 2, 2008
Jose Manuel Barroso, European Commission President

 “I am confident that the ECB will respond to the challenges of slow growth and inflationary pressures as proficiently as has been the case in the past…inflationary pressures, originated namely by high energy prices, in a context of slow growth are a real concern. The rise in food prices is also a complex and real issue. That is why the commission presented a communication on food prices for discussion at the European Council in three weeks' time…It is necessary, in our view, to secure a proper functioning of the food supply chain and of the retail sector.” – June 2, 2008

Klaus Liebscher, European Central Bank Governing Council Member

“No one can convince me that it's possible (to) promote economic growth by pursuing a lax monetary policy.” – June 2, 2008

“No doubt, the current environment is a challenge. But we will do everything needed for inflation to recede again.” – June 2, 2008

Richard Lee is a Currency Strategist at FXCM.