In the United States, as was widely expected, the FOMC decided to leave its interest rates on hold, as they met on June 24 & 25, after cutting the Fed Funds rate seven times since September 2007. In its press release, the FOMC pointed out that the balance of risks has changed. The risks of inflation have risen: inflation is higher as well as some other indicators of inflation expectations. Price rises will likely slow down during the year and in 2009. This wording is thus more cautious than the April press communiqué which was mentioning a slowdown in the coming quarters. Conversely, “economic activity continues to expand” (previously it was deemed weak), partly reflecting some firming in household spending. Note that in May retail sails grew significantly, up 1.0% m/m, as purchases were undoubtedly boosted by the implementation of the fiscal stimulus plan: the first rebate cheques were sent in late April, and the process will continue until July. The danger of a contraction in activity in the first half now seems ruled out. However, the FOMC’s press release referred to a new risk weighing on growth, namely the rise in energy prices. For the time being, despite this noteworthy change in its wording, the Fed’s bias remains neutral. Nonetheless, the next move in interest rates will likely be a rate hike. Expected in the United States and imminent in the Eurozone, monetary tightening is already under way in emerging economies. In these countries, domestic demand has so far bolstered G7 foreign trade while playing a part at the same time in the surge in commodity prices. Emerging countries are now also beginning to realise the scale of inflation risks The Reserve Bank of India has raised its rate repo by 50 basis points to 8.5%, its highest level in more than ten years. The Taiwanese central, for its part, has raised its key intervention rate by 125 basis points. In the Eurozone, there is an ever starker contrast between data relative to activity, on the one hand, and prices on the other. This divergence leaves the ECB facing a real monetary policy dilemma. Thus, according to the flash PMI survey, economic activity in the euro zone was noticeably sluggish in June. The composite PMI business activity index slipped under 50 for the first time in nearly three years. Moreover, the new order index remained under 50 for the second month in a row, suggesting that economic conditions could further deteriorate in the next few months. Economic sentiment deteriorated drastically in the Eurozone. According to the European commission Business and Consumer survey, the indicator fell to 94.9, its lowest level in more than three years. Germany has not been spared by the slowdown. According to the IFO survey, the business sentiment index declined markedly in June, dropping to 101.3, i.e. an eighteen-month low. The deterioration was noticeably significant in manufacturing industry. Moreover, pressures on prices are building up in the Eurozone, as was shown by changes in the input price and output price indices of the flash PMI survey. The latest data available on Germany (3.4%), Belgium (5.8%, its highest level in 24 years) and Spain (5.1%) help to anticipate that inflation rose from 3.7% in May to 3.9% in June in the whole area. The Flash estimate will be released on Monday 30 June. Moreover, households are increasingly worried about price rises, now their main concern, still far ahead of employment. Against this backdrop, Jean-Claude Trichet pointed out, before the European Parliament, that the risks weighing on prices have further increased. The ECB is accordingly in a “state of heightened alert” and is determined to ensure the firm anchoring of inflation expectations. Apparently, everything confirms that the ECB is ready to raise its interest rates by 25 basis points next week although this will not be followed by a series of rate hikes. To view the charts and graphs please open the PDF file on the left.