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Fed in focus; eyes also on oil, gold, dlr

LONDON - The Federal Reserve takes centre stage next week as it sets -- probably cuts -- interest rates, with investors’ focus also on oil and the euro at record highs and the dollar at all-time lows.

The October U.S. employment report will be released on Friday, two days after the Fed’s decision, and flash euro zone October inflation and a host speeches by European Central Bank officials could also potentially sway investors’ view on policy.

The Fed is widely expected to cut borrowing costs following a string of weak economic indicators and U.S. banks’ earnings reports that have shown heavy losses and writedowns resulting from the subprime mortgage market collapse and credit crunch.

The only question on investors’ minds is: Will the Fed lower its fed funds rate a quarter percentage point to 4.50 percent, as most observers believe, or will it repeat last month’s surprise 50 basis point easing?

Lena Komileva, chief economist at Tullett Prebon in London, expects a 25 basis point cut.

“Credit markets remain dislocated, the slowdown in the housing market has intensified and there’s no let up in prospect ... and the inflation outlook remains benign in the short term, which allows the Fed to focus more on the risks to growth,” Komileva said.

”Clearly, the Fed has a bias to front-loading easing, and after last month there’s no pressure on them to increase the pace of cuts.”

The Federal Open Market Committee will announce its decision at 1815 GMT on Wednesday after a two-day meeting. Interest rates futures markets are currently fully discounting a quarter-point cut, and attaching around a one-in-ten chance of a 50 basis point move.

Gold, oil surge

In terms of U.S. economic data next week, the biggest will be the October non-farm payrolls report, which is expected to show a net 90,000 rise in jobs created and the unemployment rate holding steady at 4.7 percent.

The shock 4,000 job decline in August was later revised to a gain of 89,000 and September saw an increase of 110,000.

Developments centring on the United States, such as banks’ financial hits and the crumbling housing market, have dominated market sentiment over the last few weeks.

Banking giants Merrill Lynch MER.N, Citigroup C.N and Bank of America BAC.N have posted third quarter losses and writedowns worth billions of dollars.

In turn, expectations of further Fed policy easing have pushed the dollar to record lows, supported global equity prices, helped send commodity prices soaring and lifted bonds.

The dollar’s slide to a new low against a basket of six major currencies .DXY and record low against the euro has been a key driver of crude oil surging above $90 a barrel CLc1 and gold hitting a 28-year high of $778.25 an ounce XAU.

“The dollar remains weak. This will act as a tax on (U.S.) economic activity as although it helps the export sector longer term, the short-term effect of higher prices is effectively a further tax on discretionary spending,” wrote Charles Diebel, head of rates strategy at Nomura in a note to clients on Friday.

Once barely-believable levels of $100 a barrel and $800 an ounce aren’t too far away, prompting some analysts to warn policymakers that they ignore the inflationary signals from these prices, at a time of slowing growth, at their peril.

Although the strong euro acts as a cap on price pressures, the cost of importing $90 oil puts upward pressure on inflation.

The initial estimate for October euro zone annual inflation on Wednesday is expected to show a rise to 2.3 percent from 2.1 percent in September, inching further above the ECB’s upper target of 2 percent.

”The ECB should ... be able to see through the temporary inflation spike of the next few months and stay on hold (at 4 percent) until well into 2008,” Bank of America said in a note this week.