Oil races above $135, stocks and bonds shudder

Record high oil prices at $135 a barrel deepened worries about inflation on Thursday and weighed on some Asian stocks although Japanese shares ended slightly higher, as dealers trimmed their bets on further weakness.

The dollar trudged higher against the euro after earlier hitting a one-month low after the Federal Reserve slashed its United States 2008 growth forecast, warned of higher unemployment and raised its inflation predictions, weighing on government bond prices.

European stocks dropped in early trade on Thursday in a broad retreat, falling for the third session in a row on inflation fears after a gloomy outlook by the Federal Reserve.

By 7.15am GMT, the FTSEurofirst 300 index of top European shares was down 0,4% at 1 334,83 points.

Minutes from the Federal Reserve’s April 29 to 30 policy meeting warned of mounting concerns over inflation, making further interest rate cuts unlikely at a time when the US economy may be in a recession and oil prices have risen 40% so far in 2008.

“The Fed is in a difficult position now because it’s not the US economy that is driving inflation but the Chinese,” said Damien Boey, equity strategist at Credit Suisse First Boston in Australia.

“So we end up with the situation where rather than inflation being a sign of strong demand, inflation actually eats into the consumer purchasing power.”

Tokyo’s Nikkei average closed 0,4% higher, or 52,16 points, at 13 978,46. Asia stocks outside of Japan declined 0,6% to 491,89, according to the MSCI index The index has fallen for the third straight day.

The oil surge favoured energy firms such as Nippon Oil, which rose 4,87%, but sent fuel-dependent airlines into a tailspin. Cathay Pacific slid 1,935%, Qantas dropped 4% and Korean Air fell 4,5%.

Investors, however, shunned Japanese government bonds, which slipped after three days of gains because of the mounting inflation threat from escalating oil prices.

“We are moving away from stagflation to inflation,” said Freddy Lim, chief Japan fixed-income strategist at Morgan Stanley.
“The better the Fed is at forestalling a further crisis, the worse it is for inflation. People are talking about this a lot and are very concerned.”

Stagflation

After rising to a high above $1,58, the euro slipped 0,2% to $1,5767. Against the yen the US dollar was relatively unchanged on the day at ¥103,08.

Many analysts viewed the dollar’s small comeback as short-term in nature and expected more weakness in the days to come as a result of the Fed’s grim picture of rising price pressures and stagnant economic growth.

“The dollar is under significant pressure as the market is now contemplating a stagflationary scenario, as opposed to higher rates under more stable growth conditions,” said Geoffrey Yu, currency strategist with UBS in Zurich.

The dollar’s weakness only added to the appeal of crude oil which powered to a fresh record of $135,04 a barrel.

“The huge draw in crude inventories was surprising. All focus is on bullish factors. You simply have to follow the trend and buy now,” said Tatsuo Kageyama, an analyst at Kanetsu Asset Management in Tokyo.

The strong demand for oil and fear of inflation has spurred buying of gold which climbed above $935 an ounce for the first time in a month. Gold rose to a record $1 000 in March as equity markets around the world slumped but it fell back below $850 after the panic subsided.

Buffetted

Fretful investors got little comfort from Warren Buffett, the world’s richest person, who said that economic pain was likely to run for a while longer and could get worse.

“I think the tidal wave that hit various financial institutions since last August has largely been recognised and felt,” Buffett told a news conference in Madrid at the end of a European tour.

But he said that for banks at least the worst was probably behind them after the Federal Reserve staved off “really contagious financial panic” with its intervention to prop up investment bank Bear Stearns

“In terms of the effect on the economy in the United States, we don’t know, but I think it will be longer and deeper then many people do. There could well be a lot to come.”

Prices for 10-year Japanese government bond futures were down 44 basis points to 135,42 after a disappointing Bank of Japan buying operation flushed unwanted bonds into the market.

The yield on the benchmark 10-year Japanese government bond, which moves inversely to the price, was up to 1,66%, compared with 1,605% on Tuesday.

US Treasury debt prices also slipped, with the 10-year note down 3/32 for a yield of 3,82%. - Reuters

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