In the past I have been optimistic about structural inflationary pressure within the UK economy as it has seemed to me that much of the strain has been imposed by products beyond the control of the Bank of England rate control policies. The price of Oil and Corn could not give a monkey's about what the interest rate is in little old England. This argument still holds good to a certain extent but the recent moves in worldwide commodities mean that producers will be forced, yet again, to either raise prices or squeeze margins. In the economies of China and India the pressure will be taken up by inflationary price hikes. However with the ?old? economies, which are weighed down with debt or slow growth (or a combination of both), it is more likely to be margins that take the hit. Not a good prospect for the Stock Markets.



As Simon Denom of Financial Spreads recently said, ?Since the turn of the century events have conspired to keep inflation low even in booming economies no matter what the central banks were doing. The euro zone has had a wildly divergent growth pattern with Ireland and Spain roaring away whilst France and Italy have struggled but the inflation rates in all the various countries has remained very much on an even keel. Whilst Central Bankers have patted themselves on the back for keeping the ?inflation monster? in his bottle it is difficult to get away from the feeling that he would have remained firmly stopped up even if rates had been at much lower levels?.

Even so in June the European Central Bank set the cat amongst the pigeons by being the first of the major blocs to indicate that, far from wishing to protect growth with rate cuts, they are more inclined to fight inflation. In the markets, or pretty much any other currency market, Jean Claude Trichet sent the Euro flying against the Dollar as traders bought into the higher yield story.

Until Mr Trichet's statement the markets had been quite somnolent over both the Bank of England and ECB rate announcements (unchanged as expected) with the general trend actually towards a fading Euro. His effective guarantee of a rate hike in July was truly a surprise and flies in the face of more recent central bank policy of trying to float intentions via less outright methods.

What the weaker economies in the Euro bloc must be thinking at the moment is probably unprintable as the ECB once again focuses solely on events in France and Germany and ignores the struggling satellite nations. Italy, Spain, Portugal, Ireland and Greece (the unflatteringly named PIIGS) are seriously struggling with massive economic problems which are not being helped by either the strong currency or the high interest rates.

Mr Berlusconi in particular, never a fan of the EC experiment, must be seriously tempted to publicly voice disapproval with ECB policy and to once again shake the weapon of disengagement from the whole project.

Of course the mechanics of such a desperate measure are difficult to contemplate and therefore any threat along these lines will probably be pretty much ignored as being practicably unworkable. Can you imagine the effort required in turning all bank accounts back into Lire, recalling Euro notes to issue less valuable local currency etc. But, below the surface, there is plenty of dissatisfaction with the way that the central banks seem to concentrate on the major bloc partners. If this is truly building into the worst economic crisis since the nineteen thirties (an oft mentioned comparison that, frankly, seems very unlikely) then the stresses on the Euroland financial system are going to get a lot worse.

In the ECB's defence they are, like the Bank of England, solely charged with an inflation fighting mandate and the Germans, of course, have historical experience of a Hyperinflation disaster. Unfortunately for policy makers the independence of the central bank is now working to undermine the whole stability of the Union itself.