European Rate Hike? Close, But No Cigar

The European Central Bank (ECB) will meet later this week...and not raise rates, contrary to popular belief. Inflation is now the center of attention in the global economy. It's certainly supported by some measures of quantitative easing (QE) by the large economies. Inflation is seen clearly in the surge in commodity prices; partly from supply disruptions in oil and agriculture. Bond markets responded with higher yields, and the currency market sent the Euro to its highest levels following past months of declines from debt woes.

The Euro-zone is still risky, and now is not the time for a rate hike. Trichet continues to press for better fiscal sanity, while Sarkozy and Merkel work on more monetary support for struggling countries. Portugal will host another round of treasury auctions at the same time of the ECB interest rate meeting - strategic time slot, say if the auctions go bad or credit agencies voice concerns again, hopefully some positive remarks by ECB heads will help the Euro -- or if rates are kept unchanged, a successful bond sale will lighten the mood. The bottom line is that the foundation is still being built, let's not get ahead of ourselves.

However, the UK is one to watch. With inflation above target, and 2 votes for a rate hike back in the January meeting, there's some cool jitters about a spunk in the economy. But, the expectations are high, and the UK hasn't delivered what the markets want yet. 4Q GDP came out low, and Governor King states that he wants wages to go up, and better determine risks.

Overall, the markets don't forget about risk. The risks of a double dip or deflation. The big economies are still in a tight fiscal condition. The US is under threat with debt levels reaching its ceiling, and tough lash outs from Moody's about a possible slight credit rating devaluation if we don't get our act together. The Euro zone still has problems with debt, unemployment (especially Spain near 20%). All of this should press Central Banks to support more inflation. Remember, even the US Fed continues to set high targets on inflation because they have factored in slight up-tick moments like the present situation. It's simply not the right kind of inflationary condition for a rate hike.

The markets are rallying up because they are increasing their expectations, but I predict it's a build up of excitement. Countries have a long road ahead, and a lot to prove. Also, where's the talk on the housing markets - a key indicator for any possible rate hike. It's still in the ruts, and a rate hike in the Euro zone will severely hurt Spanish mortgages. The US is in no condition either to afford rate hikes amidst mortgage modifications. It's simply absurd to not even include employment - a major problem in all major economies.

We will have to wait this one out. Investors will have a close eye on these upcoming series of economic data, and expect currency values to drop back to previous levels.