When Inflation doesn't Work!

The cost of living in Euro-zone and UK rose in June but the market reaction looks completely different to what you may remember from July. At that time, rising inflation headlines in addition to revived concerns on the health of the U.S. financial institutions, Freddie Mac and Fannie Mea specifically, helped both Euro and pound reaching their records highs against the dollar. However inflation my look not so frightening when everything pointing to the possibility of a sharp slowdown in global economic activity:

• IMF's World Economic Outlook Update in July pointed to an increasingly slowing economy in the UK, EU, and Japan.
• Gross Domestic Product shrunk in Euro-area in the second quarter, for the first time since introducing the Euro, after economy contracted in Germany and France, the two largest euro economies.
• Japan GDP also showed that the world second largest economy contracted at an annualized 2.4 percent in the second quarter when Japanese officials earlier warned about it.
• The data also showed negative numbers for Industrial Production in Japan, France, and Euro-area.
• Moreover, the war in Georgia just increased concerns about the security issues in European economies.

There were certainly reactions to this situation. Commodity prices lead by oil extended their declines. One month ago it was really difficult to imagine gold at 772 $/ounce but it happened on Aug 15.

The only winner was certainly the dollar which appreciated against all major currencies. The depreciation of sterling was the most in almost 37 years. Nevertheless, I think the appreciation of the greenback against the Yen was somewhat limited which may come from a widely reduction in carry-trading.

Finally, almost all economic data for the week were overshadowed, positively or negatively, by the big-picture which was the fear of a global economic slowdown. There was almost no significant reaction to the GDP or CPI in Euro-zone at the time of the releases showing that most of decisions had been already made.