The Daily Reckoning’s Chris Gaffney looks ahead to a week of interest rate decisions from the world’s major central banks.

The Fed isn’t going to change rates today, and it probably won’t for the rest of the year. Raising rates would send the housing and financial markets over the edge. Cutting them would spur an already dangerous inflation problem.

Elsewhere, central banks find themselves in the similar position. But while the Bank of England follows the Fed, the ECB is prioritizing the fight against inflation. This spells bad news for the US dollar and British pound, especially against the euro. More from Chris…

It should be an exciting week, as it is ‘Interest Rate Decision’ week, and a number of central banks will be announcing their new rates. I think the rate announcements will reinforce my feelings that the world’s economies are heading down divergent paths, with some economies heading toward a recession while others maintain good growth rates.

We will also get one of the Fed’s favorite measures of inflation, the PCE Deflator. The PCE Deflator is expected to show that prices in June jumped by the most this year causing some to call for more rate hikes. This is what has caused the dollar to gain some ground this morning during early European trading. The FOMC will announce their interest rate decision tomorrow, and everyone is predicting they will hold rates steady (as if they have a choice!). As usual, the markets will be dissecting the accompanying statement to try and predict the FOMC’s next move. They continue to be stuck in the unenviable position of dealing with rising inflation and a slowing economy. Don’t expect any change from the ‘wait and see’ language which they have been feeding us.

Chuck is heading out to San Francisco for another investment conference later this week. Last night, while watching the Cardinals blow yet another game, he emailed me his thoughts on the upcoming week:

“I was reading a story in the Post this weekend, by John Berry, the former Fed Head, that pretty much stated what I’ve been telling people, especially the crowd in Vancouver… The Fed Won’t Raise Interest Rates this week… And in my mind, they probably won’t this year. Yes, inflation is rising, but it’s not wage spiraling inflation that usually pushed the Fed Heads to raise rates. And with the housing, credit, liquidity, and financial institutions’ problems running rampant, the Fed Heads just can’t raise rates, as raising them would make all those problems balloon! Yes, I know, the Fed Heads have been great at creating bubbles, but this would be worse than a bubble… It would be a Hindenburg!”

As Chuck points out, the Fed simply can’t raise rates; and with the poor data, another drop wouldn’t be too surprising. But no, Big Ben and his compatriots have been paralyzed by the combination of rising inflation and a slowing economy. As we have been saying, the FOMC will be forced to just take their seats and hold on for the ride. In the past, when the U.S. economy weakened, the rest of the world usually followed quickly and inflation eased as demand for oil and other commodities fell. But the world’s expansion barely slowed last year and the commodity cycle continued on its long term upward trend. Economies in Asia continue to expand, keeping the world on an upward growth path in spite of what is occurring here in the United States. So the Fed can’t count on a global slowdown to bring prices down, but if they raise rates to combat inflation, they will deepen the recession that the U.S. is already in. They seem to want to err on the side of growth, and hope inflation takes care of itself; not a good scenario for the U.S. dollar!

The ECB finds itself in a similar position, but has decided to err on the side of controlling inflation and risking a further slowdown in their economy. This is a much more conservative approach, and one that I believe will turn out to be correct. European producer prices increased by the most in at least 18 years in June, challenging the ECB’s mantra of providing price stability. The ECB will meet on Thursday, and most believe they will leave rates unchanged after lifting rates to a seven-year high last month. President Jean-Claude Trichet said that the ECB council “will do in the future what is appropriate to deliver price stability.”

The Bank of England has taken a path similar to the U.S. FOMC, and the pound sterling (GBP) has suffered because of it. The pound posted its biggest weekly decline against the dollar since mid-June, as U.K. manufacturing shrank last month by the most in a decade, adding to evidence of a recession. U.K. house prices fell the most in nearly two decades in July, and consumer confidence dropped to a record low, reports showed last week. The British economy is very weak, and there are currently no signs of a recovery. We expect the pound to continue to weaken, especially versus the euro (EUR) and also against the dollar.

Australian house prices also fell in the second quarter, the first time prices have gone down in almost three years. Central bank Governor Glenn Stevens is counting on falling house prices to help cool inflation that has accelerated above his target range of 2% to 3%. Stevens raised the benchmark rate in March, and policy makers will be meeting again tomorrow to review interest rates. While no change in rates is expected, some are expecting the Reserve Bank of Australia to signal a move toward cutting borrowing costs to spur growth. It will be interesting to see what Governor Stevens has to say after the meeting. I don’t expect any shocks like what we saw out of NZD with Bollard turning extremely dovish. With the overall commodity boom cycle continuing, I disagree with those expecting a cut from the RBA, and believe Stevens will continue his ‘wait and see’ approach, with a hawkish bias.

Source: A Week of Interest Rate Decisions