Gold News

Gold Slips from One-Week Highs vs. Dollar & Euro as ECB Sticks, Bank of England Cuts Rates Despite "Sharp" Inflation Fears

Gold Prices rose steadily in Asia on Thursday, gaining 2.6% from yesterday's low vs. the Dollar and hitting a one-week high of €623 per ounce as the European Central Bank met to decide Eurozone interest rates.

The Gold Market then dipped 0.6% after the Bank of England voted to cut UK lending rates by a "baby step" 25 basis points to 5.25%. The ECB kept its key lending rate on hold at 4.0% as forecast by all 55 economists surveyed by Bloomberg News earlier this week.

"The political pressure is being built up on the ECB to lower the interest rate and actually follow the policy delivered in the US Fed," believes Thorsten Polleit of Barclays Capital.

"[But] inflation is the biggest challenge, the biggest risk, to monetary policy right now."

Inflation in the
Eurozone hit a 14-year high of 3.2% in January – the fifth month
running that the cost of living rose ahead of the Bank's 2.0% target.

"One reason is that money and credit remain at a very elevated level," says Polleit, "and historical experience suggests that sooner or later that might increase inflation and then we have a big problem, especially here in Europe."

Between 1968 and 1998, according to a 2001 speech by Mervyn King – now governor of the Bank of England in London – the correlation between growth in the world money supply and global inflation averaged 0.98, a near-perfect connection.

Indeed, "few empirical regularities in economics are so well documented as the co-movement of money and inflation," King said at the time.

But more than six years later, the UK's money supply is now expanding by 12.3% per year, adding to inflationary pressure even as the Bank cut its key lending rate today to counter a marked decline in UK property prices.

The Bank of England voted this morning to cut its base rate by 25 basis points to 5.25%, saying that it needed to balance expectations of "sharply" rising inflation against "continued disruption to global financial markets."

Incredibly, the British Pound briefly rallied on the cut, suggesting that some forex traders had expected a 0.5% drop after news this morning that UK industrial output contracted for the second month running in Nov.

But Sterling soon fell back towards a two-week low of $1.9510 against the Dollar, while Gold Price in Pounds Sterling rose to a five-session high of £466.25 per ounce.

Gold has now risen by 19% for British investors and savers since the Bank of England first cut its rates to counter the global banking crisis in Dec. Just this morning Northern Rock Plc – the first British bank to suffer a "run" in 130 years – was added to the public sector's balance sheet by the official UK statistics agency.

NRK has effectively belonged to the nation since it demanded unconditional government support in Oct., the agency said.

The UK stock market today plunged to a 1.8% loss in response to the Bank's rate cut, while over in Frankfurt, the Dax dropped 1.2% ahead of the ECB's rate decision on news that German factory orders fell by 1.7% in Dec. from the month before.

The European single currency meantime held in a tight range below $1.4640, and Societe Generale in Paris – the second largest bank in France, hit by €4.9 billion "rogue trader" losses last month – found it may be forced to delay an emergency €5.5bn capital raising.

The US Securities and Exchange Commission (SEC) is reported by the Financial Times to be investigating how SocGen unwound Jérôme Kerviel’s huge derivatives bets at the end of Jan.

Closer to home, Wall Street futures pointed lower as the US opening drew near today, with Pending Home Sales for Dec. due to be announced at 10:00 EST.

Residential real estate will continue to drag on the US economy until 2009, said Charles Plosser, president of the Philadelphia Fed, to an audience in his home-town of Birmingham, Alabama on Wednesday night. But that doesn't mean inflation in the cost of living will subside, he went on.

"I expect little progress to be made in reducing core inflation this year or next," Plosser said, "and I am skeptical that slower economic growth will help" – a blunt contradiction of the FOMC's most recent policy statements.

"All you have to do," Plosser warned, "is recall the 1970s, when we experienced both high unemployment and high inflation."

The stagflation of the late 1970s saw Gold Prices surge eight-fold as interest rates failed to keep pace with the cost of living. US equities lost one-third of their value after inflation.

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Adrian Ash

Adrian Ash, BullionVault Gold News

Adrian Ash is director of research at BullionVault, the world-leading physical gold, silver and platinum market for private investors online. Formerly head of editorial at London's top publisher of private-investment advice, he was City correspondent for The Daily Reckoning from 2003 to 2008, and he has now been researching and writing daily analysis of precious metals and the wider financial markets for over 20 years. A frequent guest on BBC radio and television, Adrian is regularly quoted by the Financial Times, MarketWatch and many other respected news outlets, and his views from inside the bullion market have been sought by the Economist magazine, CNBC, Bloomberg, Germany's Handelsblatt and FAZ, plus Italy's Il Sole 24 Ore.

See the full archive of Adrian Ash articles on GoldNews.

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