The euro rallied about 80 pips, or 0.6 percent, on hawkish comments from European Central Bank (ECB) executive board member Lorenzo Bini Smaghi.

Bini Smaghi made the remarks in a Bloomberg interview.

“As the economy gradually recovers and global inflationary pressures arise, the degree of accommodation of monetary policy has to be monitored and, if needed, corrected,” he said.

Moreover, the inflation in commodities will “have an unavoidable impact,” he said.

Indeed, loose monetary policy around the world is already driving up inflation in several developing countries, which have begun to raise rates aggressively.

Now, it may be spreading to Europe.

The year-on-year inflation for the euro zone was 2.2 percent in December 2010 and 1.9 percent in November 2010. The December inflation figure exceeded the ECB’s target of 2 percent. Now, coupled with Bini Smaghi’s hawkish comments, it seems possible that a rate hike may come as early as this year.

Inflation in the United Kingdom has also picked up even more quickly.   

It has spiked to 4.0 percent for January 2011 and 3.7 percent December 2010. The Bank of England (BOE) also has an inflation target of 2 percent, so its pressure to raise rates is probably even greater than that on the ECB.

Meanwhile, year-over-year inflation in the US was only 1.6 percent for January 2011.

If inflation differences between the US and Europe continue to widen, the dollar is expected to weaken because higher interest rate currencies tend to appreciate against lower interest rate currencies. 

If the social unrest around the world also begins to settle, the demand for the US dollar may further weaken.

Email Hao Li at hao.li@ibtimes.com

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