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Sunday June 8, 2008 - 21:50:30 GMT
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Jean Claude Trichet, President of the European Central Bank (ECB) has
to be a bit surprised at some of his handiwork. The collapse in the
dollar and the Dow and the record rise in crude oil were not all his
doing. Serious supply concerns, Israeli threats, Asian demand and a violent short
squeeze helped drive the oil market to record levels. Non Farm Payrolls
and particularly the unemployment rate, which jumped 0.5% to 5.5% in
May and renewed financial sector worries, slammed American stocks.
But it was Mr. Trichetâ€™s comment that the ECB â€ścould decide to move
rates for a small amount in our next meetingâ€ť that cut the legs out
from under the dollar and started the huge spike in oil prices. No one
in the markets expected such a move by the ECB. When the value of
dollar declines the cost of crude oil, priced in dollars, rises. For
the American consumer, the price of crude oil has a direct translation
into consumer spending. A sustained contraction in consumer spending
will surely push a fragile US economy into recession. The American
economy has a new and immediate threat as oil now seems poised to race
Mr. Trichet has long had a policy of informing the markets of the
internal discussion of the central bank governing board. In letting the
market know that a rate increase was advocated by several board members
and could happen in July he was simply continuing that policy. His
comment was then reinforced by Axel Weber, president of the German
Central Bank and ECB board member when he said that the market â€śseems
to have well understoodâ€ť the â€śstrong signalâ€ť that the current inflation
situation is not â€śacceptableâ€ť. Indeed it did, but at what cost?
Mr. Trichet has often and publicly called for US officials to support
the dollar. Ben Bernanke, the Chairman of the Federal Reserve, finally
did so early in the week and it was one of the reasons the dollar had
reached its highest point against the euro in more than a month on
Thursday. But any positive effect on the dollar from the Fed Chairmanâ€™s
comments was swamped by the adamancy of the ECB.
The ECB is rightly concerned about inflation with the latest harmonized inflation reading 3.6% in May almost double the
bank's target of 2.0%.
But oil and energy prices are one of the main drivers of European and
worldwide inflation. The price of crude had fallen to below $122.00. On
Friday it closed at $138.54. The dollar lost 2.6% against the euro on
Thursday and Friday; the price of oil rose more than 8.4% on Friday
alone. The Thursday and Friday rise in oil on the New York Mercantile
Exchange was a record for the exchange.
The ECB has damaged its own case against inflation. What
will generate higher inflationary expectations more than a sharp hike
in gasoline prices? Would not a sustained 15% or 20 % drop in the price
of oil do more to counter inflation in Europe than threatening to push
a rate increase on a slipping European economy? Will not higher energy
prices further undermine European GDP and fracture consumer spending?
The European consumer should be the beneficiary of a strong
euro with increased purchasing power for foreign goods. But retails
sales in Europe fell unexpectedly 0.6% in April, the fifth fall in the
six months to April. European consumers have historically
underperformed their American counterparts. It seems clear that the
European consumer is more attentive to historical precedent, more
attune to pessimism than optimism. Exactly the opposite of the US
The US economy is weak, payrolls have fallen for five straight
months, but it is not yet recessionary. The total job losses since
January are about what were recorded in one month during the 2001
recession. The unemployment rate rise to 5.5% was likely a product of
an unprecedented number of young workers reaching the job market in May
and skewing the seasonal adjustment to the unemployment rate. (You can
easily see parents of vacationing college students saying, the economy
is weak get out there early and find a job). A portion of the 0.5%
increase will probably return in June. Without this group the
unemployment rate in May would probably have been 5.2% or 5.3%.
But the American economy can ill afford the hit to consumer spending
that will follow a crude oil price of $150 a barrel. The lower the
dollar falls the higher the price of oil climbs. The ECB may have
started an avalanche that will bury their inflation worries in a
Chief Market Analyst
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