Western Policy-Makers Refuse to Raise Interest Rates to Combat Surging Inflation

By: Adrian_Ash

SPOT GOLD PRICES slipped out of a tight range just before the US open on Tuesday as strong volatility hit bonds, commodities and currency markets worldwide.

Shanghai stocks dropped almost 3% on average, while crude oil slid $7 per barrel from Monday's new record highs near $140.

India 's BSE share index climbed 2% for the session, but remained one-quarter below its January start. European equities jumped, and Wall Street futures pointed to a higher start, after Western policy-makers said they're unlikely to raise the cost of borrowing despite the strong rise in global inflation.

"Increasing interest in inflation across all major regions is now starting to play on people's minds," reckons Daniel Hynes at Merrill Lynch.

"Higher-than-expected inflation would probably support Gold , but that is going to be capped by the possibility of rate hikes."

But open-market interest rates fell early Tuesday, with two-year US Treasury bonds bid higher from yesterday's six-month low on expectations of weak Housing Starts construction data for May.

Producer Price inflation in the US – also due for release at 08:30 EST – was forecast to show a rise of 6.7% from May '07.

On the foreign exchange markets the British Pound was sold hard after the UK first reported a 16-year record in retail price inflation, but the country's chief central banker then said the Bank of England will not raise interest rates to defend the purchasing power of the Pound.

"Inflation is likely to rise sharply in the second half of the year, to above 4%," admitted Mervyn King in the open letter he's obliged to send the UK finance minister if Consumer Price inflation breaches 3.0% per year.

With the CPI rising by 3.3% from May 2007, "I expect this to be the first of a sequence of open letters over the next year or so," the Governor went on, effectively abandoning his inflation target for the time being.

"If Bank Rate were set to bring inflation back to target within the next 12 months, the result would be unnecessary volatility in output and employment."

The British Pound dumped two cents to the Dollar inside one hour of Dr. King's letter being made public. It fell back to a one-week low vs. the Euro.

But for British investors looking to defend their savings and wealth in Gold Bullion , the price moved back to Monday's one-week highs above £454 per ounce.

The Gold Price in Sterling has risen 38% since this time last year. It's more than doubled since June 2003.

"Gold's current range [in US Dollars] is from $870 to $890," says today's Gold Market note from Mitsui, the precious metals dealer here in London .

"A break of the downtrend line at $900 would be needed to really inject some life back into this market. The trend at the moment is technically neutral.

"Should gold trade below $850," adds Mitsui in its latest study of the global refining industry, "a significant appetite from the physical community will likely emerge and this consumption would act as an important floor in the current trampoline of reverberating Gold Prices .

"According to our friends in India , the physical community is waiting on the sidelines for a test of this important level before further gold purchases are considered."

Back in the forex markets on Tuesday, the Euro slipped back vs. the Dollar after Lorenzo Bini Smaghi – an executive member of the European Central Bank – said a rate-hike in July would probably be a one-off.

"In our view such a tightening, which I would call significant even if it is just 25 basis points, should be able to bring inflation back below the 2.0% target in the next 18-24 months," said Bini Smaghi to the Italian Il Sole 24 Ore newspaper.

Inflation in the Eurozone has now risen above the ECB's target for nine months running. German investment confidence has sunk to a 16-year low in May, the ZEW consultancy reported this morning, plunging from -41.4 to -52.4 points as economic growth slows and oil prices continue to rise.

Today the government of Iran in Tehran confirmed it's been Buying Gold after withdrawing €48 billion ($75bn) from Euro-denominated assets to side-step European sanctions against its nuclear research program.

"Part of Iran 's assets in European banks have been converted to Gold and shares," said the deputy minister for economic affairs at Tehran 's foreign office, Mohsen Talaie, "and another part has been transferred to Asian banks."

Speaking at a meeting of the Opec oil cartel's Fund for International Development in Isfahan , the Iranian president today blamed the weak US Dollar for the surge in global energy prices.

"As you know," Mahmoud Ahmadinejad claimed, "the decrease in the Dollar's value and the increase in energy prices are two sides of the same coin."

By Adrian Ash
BullionVault.com

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City correspondent for The Daily Reckoning in London and a regular contributor to MoneyWeek magazine, Adrian Ash is the editor of Gold News and head of research at www.BullionVault.com , giving you direct access to investment gold, vaulted in Zurich , on $3 spreads and 0.8% dealing fees.

(c) BullionVault 2008

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