Changes in Europe’s monetary policy have far-reaching effects on commodities and inflation around the globe

FactSet’s Sara Potter, VP, Market Analysis, examines the European Central Bank’s recent decision to raise interest rates, and how its effect on the value of the dollar is impacting commodity prices. 

The April 7 rate hike announcement by the European Central Bank (ECB) was in line with market expectations and signaled an end to the loose European monetary policy that has prevailed for the last two years. With expectations for more ECB rate hikes on the way, and predictions that the Federal Reserve will not follow suit in the short term, markets are anticipating that the dollar may weaken further against the Euro. This dollar weakness has repercussions beyond U.S.-Europe trade flows; since oil and other global commodities are priced in U.S. dollars, commodity prices surged on news of the rate increase.

The irony here is that high commodity prices are already to blame for the soaring inflation in all corners of the world, forcing central banks everywhere to raise interest rates. Agricultural commodities such as corn and wheat are at the core of rising global inflation. A confluence of events, including crop failures due to bad weather, the imposition of export restrictions by exporting countries, and grain hoarding in the troubled nations in the Middle East and Northern Africa, have all combined to create a perfect storm of upward price pressures.

Not surprisingly, the ongoing turmoil in the Middle East has also pushed up energy prices. Since bottoming out at less than $40 per barrel at the end of 2008 in the midst of the global recession, oil prices have been pushing steadily upward; WTI crude is trading at around $110 per barrel, while Brent crude is over $120 per barrel. Precious metals, considered a hedge against inflation, are also surging. Now at over $1400 per troy oz., gold prices are up nearly 30% from a year ago, while silver prices have more than doubled in that time. 

With U.S. core inflation (excluding food and energy) still hovering at around 1%, and overall inflation at just over 2%, most analysts believe that the Federal Reserve will wait until early 2012 to start raising interest rates in order to encourage the ongoing recovery. With the ECB now taking an aggressive stance against rising inflation, the gap between U.S. and European policy rates is likely to continue to widen this year, putting additional downward pressure on the dollar and upward pressure on commodities. 

Click to enlarge any image above for a closer look at the monetary policy changes caused by the recent ECB rate hike.

FactSet clients can access these charts and more by opening:
Interactive Charting > Open Charts > FactSet > Economics > Insider Charts