The Federal Reserve faces an increasingly complicated job weighing the need for interest rate cuts to fuel the economy against the inflationary pressures building because of an accelerating decline in the value of the US dollar.
The euro surged to an all-time record against the greenback yesterday, topping $1.50 for the first time in its nine-year history in early morning trading in Asia and continuing its appreciation through the day. Last night, it stood at $1.5119 as the Fed chairman Ben Bernanke's testimony on Capitol Hill appeared to favour further rate cuts.
A steady drip of poor economic news in the US this week has led foreign exchange investors to underweight the dollar, and it fell yesterday against all the other major currencies. At one point, the pound was back up to within half a penny of the $2 mark, which it traded above during the second half of last year.
The euro, however, was particularly strong, following surprisingly robust consumer confidence figures in Germany earlier in the week, which suggested the eurozone economy is withstanding fears of a global slowdown.
"The market is counting on the Fed lowering the interest rates even further and on the fact that the European Central Bank is going to keep them where they are," said Christoph Schmidt, an anal-yst with NM Fleischhacker Trading Bank. Divergent interest rates were "good for the euro and bad for the dollar", he said.
The falling value of the dollar is fuelling fears that inflation, already close to the top of the Fed's comfort level, will creep higher. This concern has been strengthened because of the relationship between the weak currency and the rising cost of raw materials, fuel and food.
Such commodities, traded in dollars, get cheaper for non-US investors as the US currency declines, and there were more big rises in commodities prices yesterday.
On the Chicago Board of Trade, wheat was trading at a record $13 a bushel, and the prices of coffee and cocoa were at multi-year highs. The oil price was lower after data showed an unexpected rise in US stockpiles last week, but still traded above the psychologically important $100-a-barrel mark.
Mr Bernanke reiterated his view that inflation will moderate later in the year but added: "The further increases in the prices of energy and other commodities in recent weeks, together with the latest data on consumer prices, suggest slightly greater upside risks to the projections of both overall and core inflation than we saw last month."Reuse content