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INFLATION NO THREAT TO THE DOLLAR

BORIS SCHLOSSBERG<br /><strong>DIRECTOR OF CURRENCY RESEARCH, GFT</strong><br /><br />OVER the past two weeks, the US dollar has been battered from all sides, hitting yearly lows against the euro, pound and all Commonwealth currencies. Economic data has shown steady improvement, giving investors more confidence to move their capital into higher-yielding, riskier currencies. But the growing fear that US monetary and fiscal policy will lead to inflation and currency devaluation is weighing heavily on the buck.<br /><br />Looking at the latest crude oil prices, it&rsquo;s easy to see why investors are concerned. Oil had its biggest monthly gain ever in May and the impact of higher oil prices is starting to filter through the production chain. On Monday, the prices-paid component of US ISM manufacturing survey skyrocketed to 43.5 from 32.0 the previous month. Increases in commodity prices are clearly affecting production goods but will the rise in basic materials translate into inflation for consumers?&nbsp;<br /><br />Not necessarily. Production gauges in industrialised economies may have all turned higher, but consumption has been tepid at best. In Germany, Japan, the US and even Australia, recent retail sales have consistently disappointed to the downside, indicating that for consumers, the new paradigm is &ldquo;a penny earned is a penny saved.&rdquo;<br /><br />Indeed, on the same day as the ISM survey, the US also reported that while personal incomes rose 0.5 per cent in May, personal spending contracted by 0.1 per cent. In short. consumers are hoarding their money so producers will not be able to pass on price increases to the end user.<br /><br />Inflation&rsquo;s threat to the US dollar is largely overblown. With US long-term bonds sporting some of the highest real interest rates in years, the rally against the buck may be overdone for now. If investor demand for US Treasury securities remains strong, the dollar could finally catch a bid.<br /><br />Boris Schlossberg and Kathy Lien are directors of currency research at GFT. Read daily commentary at www.GFTUK.com/commentary or e-mail BorisandKathy@gftuk.com.&nbsp;