leadership

In the face of rising inflationary pressures the Fed has been lowering interest rates over the past year, in part to help banks cope with the subprime crisis. The benchmark short-term interest rate in the USA is now 2%. Facing the same inflationary pressures, the European Central Bank has stood pat over the same period of time, with its benchmark interest rate at 4%.

Recent price data in the euro-zone showed inflation peaking at 4% and created the expectation that the ECB will raise rates by a quarter of a percentage point at its next meeting on Thursday. European stock markets fell sharply today in anticipation of a rate rise with the Portuguese stock market leading the fall (-4.5%).

ECB's rate decision on Thursday is crucial to the Fed and this marks a reversal of past trends when Fed's decisions used to be crucial to the ECB. If the ECB indeed raises rates and creates the expectation of further rate rises the Fed is left with the dilemma of seeing the dollar hit new historical lows, or raise rates itself and follow the ECB leadership in the fight against inflation.

For the first time in its history the ECB might be leading World monetary policy. Watch it on Thurday. A sharp fall in US stock markets following the ECB's decision will signal that the market anticipates the Fed will follow the ECB and soon will be raising rates as well.