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Gold Weak Vs Strong Dollar - Bank of England Cuts Interest Rates Despite Inflation Fears

Commodities / Gold & Silver Feb 07, 2008 - 10:08 AM GMT

By: Adrian_Ash

Commodities SPOT GOLD PRICES for immediate delivery rose steadily in Asia on Thursday, gaining 2.6% from yesterday's low vs. the Dollar and hitting a one-week high of €623 per ounce for Eurozone investors as the European Central Bank met to decide interest rates.

The Gold Market then dipped 0.6% when the ECB kept its rates on hold. The Bank of England in London chose to cut British interest rates by 25 basis points to 5.25%.

"The political pressure is being built up on the ECB to lower the interest rate and actually follow the policy delivered in the US Fed," says Thorsten Polleit of Barclays Capital.

"[But] inflation is the biggest challenge, the biggest risk, to monetary policy right now."

Inflation in the Eurozone hit a 14-year high of 3.2% in January – the fifth month running that the cost of living rose ahead of the Bank's 2.0% target. But

"One reason is that money and credit remain at a very elevated level," Polleit told Bloomberg today, "and historical experience suggests that sooner or later that might increase inflation and then we have a big problem, especially here in Europe ."

Between 1968 and 1998, according to a 2001 speech by Mervyn King – now governor of the Bank of England in London – the correlation between growth in the world money supply and global inflation averaged 0.98, a near-perfect connection.

Indeed, "few empirical regularities in economics are so well documented as the co-movement of money and inflation," King said at the time.

But more than six years later, the UK 's money supply is now expanding by 12.3% per year, adding to inflationary pressure even as the Bank cut its key lending rate today to counter a marked decline in UK property prices.

The Bank of England voted this morning for the second 0.25% since Dec. to help balance expectations of "sharply" rising inflation against "continued disruption to global financial markets."

Incredibly, the British Pound briefly rallied on the cut, suggesting that some forex traders had expected a 0.5% drop after news this morning that UK industrial output contracted for the second month running in Nov.

But Sterling soon fell back towards a two-week low of $1.9510 against the Dollar, while Gold Price in Pounds Sterling rose to a five-session high of £466.25 per ounce.

Gold has now risen by 19% for British investors and savers since the Bank of England first cut its rates to counter the global banking crisis in Dec. Just this morning Northern Rock Plc – the first British bank to suffer a "run" in 130 years – was added to the public sector's balance sheet by the official UK statistics agency.

NRK has effectively belonged to the nation since it demanded unconditional government support in Oct., the agency said.

The UK stock market today plunged to a 1.8% loss in response to the Bank's rate cut, while over in Frankfurt , the Dax dropped 1.2% ahead of the ECB's rate decision on news that German factory orders fell by 1.7% in Dec. from the month before.

The European single currency meantime held in a tight range below $1.4640, and Societe Generale in Paris – the second largest bank in France, hit by €4.9 billion "rogue trader" losses last month – found it may be forced to delay an emergency €5.5bn capital raising.

The US Securities and Exchange Commission (SEC) is reported by the Financial Times to be investigating how SocGen unwound Jérôme Kerviel's huge derivatives bets at the end of Jan.

Closer to home, Wall Street futures pointed lower as the US opening drew near today, with Pending Home Sales for Dec. due to be announced at 10:00 EST.

Residential real estate will continue to drag on the US economy until 2009, said Charles Plosser, president of the Philadelphia Fed, to an audience in his home-town of Birmingham , Alabama on Wednesday night. But that doesn't mean inflation in the cost of living will subside, he went on.

"I expect little progress to be made in reducing core inflation this year or next," Plosser said, "and I am skeptical that slower economic growth will help" – a blunt contradiction of the FOMC's most recent policy statements.

"All you have to do," Plosser warned, "is recall the 1970s, when we experienced both high unemployment and high inflation."

The stagflation of the late 1970s saw Gold Prices surge eight-fold as interest rates failed to keep pace with the cost of living. US equities lost one-third of their value after inflation.

By Adrian Ash

Gold price chart, no delay | Free Report: 5 Myths of the Gold Market
City correspondent for The Daily Reckoning in London and a regular contributor to MoneyWeek magazine, Adrian Ash is the editor of Gold News and head of research at , giving you direct access to investment gold, vaulted in Zurich , on $3 spreads and 0.8% dealing fees.

(c) BullionVault 2008

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.

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