Great stuff as always from my hero's at Economist.com
"A number of countries with high levels of inflation have this year suffered alarming slides in the value of their currencies against the dollar or euro. Romania’s currency softened by nearly 10% against the euro in the first three months of this year. Over the same period the South African rand lost nearly 20% of its value against the dollar and the Turkish lira lost 14%, while Iceland’s krona suffered a spectacular 30% drop in value versus the euro between January and May. Inflation and large external financing needs were the common factors behind these declines. The US dollar’s decline against other major currencies, and the recent weakness of the British pound against the dollar and euro, are also down partly to inflation running well above official targets.
Until mid-2007, relatively high inflation was viewed by financial markets as a reason to buy a currency, on the basis that nominal interest rates would be correpsondingly high and might rise further. This may seem counterintuitive as high inflation erodes the buying power of the purchased currency, but it is the basis of the foreign exchange carry trade, which enjoyed a period of strong positive returns.This applied even to emerging markets with sizeable fiscal and current-account deficits.
From the second half of 2007, and particularly since the start of 2008, carry trades have become much less of a one-way bet. The perception that inflation was a problem that had been conquered by central banks, and thus was nothing to worry about, began to change. There were two reasons for this. First, the surge in commodity prices—in particular for food staples—pushed up consumer prices across the globe. The impact was particularly pronounced in emerging markets, where food takes up a relatively high proportion of the consumer basket. Second, in response to turmoil on global financial markets, central banks, led by the US Federal Reserve, loosened monetary policy through interest-rate cuts and liquidity injections. There is a perception that some central banks are now more concerned with GDP growth and the stabilisation of the financial sector. Their hard-earned credentials as inflation fighters are being brought into question." Economist.com 16th May 2008
No comments:
Post a Comment