Busch: BOE, Bernanke and Currency Wars

Bank of England. On Thursday, the UK central bank meets to decide on interest rates amidst a rising inflationary environment. Currently, the BOE is holding their asset purchases at 200 billion GBP and their overnight interest rates at 0.5%. The Monetary Policy Committee will struggle to decide if they need to raise interest rates when inflation is about double their 2% target and UK growth might be negatively impacted by government cuts in spending. On January 13th, two members of the committee voted to raise interest rates as they were concerned that inflation would become entrenched.

The question of inflation is one that is salient for all the central banks in the world. Emerging markets are particularly struggling with increases in food and energy as soaring commodity prices are pushing up consumer price indexes. As the Economist points out, China’s inflation rate is hovering around 5%, Brazil’s is approaching 6% and India’s remains close to 10%. Even in enfeebled rich economies the “I” word is back on the front pages. Britain’s consumer prices rose 3.7% in the year to December.” The problem for the central banks is timing: when will the inflection point occur where a first round commodity price increase leads to a second round wage increase?

Bernanke testifies on budget. Wednesday, Federal Reserve chairman Ben Bernanke testifies at a hearing of the House Budget Committee on “The Economy, Jobs and the Budget.” Ostensibly, this will be an opportunity for Bernanke to link the problems of the fiscal deficit to creating economic and job growth for the US economy. It will also offer an opportunity for new Budget Committee Chairman Paul Ryan to ask questions about Fed policy and fiscal policy over the last two years. While Bernanke will no doubt defend both, he will be obligated to delineate which policy had a larger short run impact and which policy was more successful in its goals.

Ben Bernanke, Federal Reserve Chairman
Ben Bernanke, Federal Reserve Chairman

This process is important as Republicans take control of the House of Representatives.

This week will be the first time that House appropriations subcommittees review budget numbers in an attempt to trim bloated federal spending.

Chairman Ryan released a budget blueprint to cap spending at $1.055 trillion for 2011. According to the Hill, “That number is $74 billion less than the budget request President Obama submitted to Congress for fiscal 2011 and $32 billion less than the level at which lawmakers agreed to maintain spending.” House Republicans want to cut $100 billion from annual discretionary spending and attempt to revert to pre-crisis, pre-bank bailout levels of 2008. While this is positive for reducing the short term deficit, the harder work remains for Medicare, Medicaid and Social Security.

Watch to see if Bernanke makes any commitment or support for cutting those programs on Wednesday.

Currency Wars. Last month, French Finance Minister Christine Lagarde stated that unfair monetary competition is incompatible with global sustainable growth and that it is necessary to set up a body that includes China to discuss foreign-exchange matters as a prior step to reforming the international monetary system. On Sunday, she went further by saying the euro must not be the victim of exchange rate manipulations by China and the United States. The euro "is a solid currency," Lagarde declared in a television interview, citing the growing interest of central banks to include it in their currency reserves. "But the euro must not become so solid and strong compared to the dollar, the yuan and the yen that it weighs too much on our competitiveness," she stressed according to MNI.

Today, US Treasury Secretary Tim Geithner was in Sau Paulo, Brazilmade this statement on the Brazilian Real. “Brazil is seeing a surge in capital inflows. This is happening for two reasons. First, investors around the world see Brazil growing at a faster pace and offering higher rates of return relative to other major economies. But these flows have been magnified by the policies of other emerging economies that are trying to sustain undervalued currencies, with tightly controlled exchange rate regimes. Brazil and other emerging economies with flexible exchange rates and open capital markets have born a disproportionate share of both the benefits and burdens of these capital flows.”

Clearly, the pressure on China continues to grow with both France and the United States stating publicly the need for change. While the US didn’t name China as a currency manipulator, other areas of the US government will likely be more aggressive in their viewpoints including the new chairman of the US House Committee on Oversight and Government Reform, Darrell Issa (R-CA).

Andrew B. BuschDirector, Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.