U.S. economy and mortgage rates

(David Beadle is a mortgage industry analyst. The opinions expressed here are those of the author. They should not be seen as representing the views of Reuters.)

NEW YORK (Reuters) - Why Gas Keeps Rising.

Gasoline prices have been rising at an increasingly rapid pace in advance of the summer driving season. This is occurring despite apparent efforts by American motorists to reduce their use of motor fuel through more careful trip planning and a switch in some cases to the use of public transportation.

Nevertheless, energy expenses continue marching relentlessly higher. If the trend continues, it could have adverse implications for the continuation of the availability of low fixed-mortgage rates.

It turns out the upward trend in price pressures is not only the result of rising global demand but also the result of a deliberate effort by our government to reduce the value of our currency to lessen the trade imbalance between the United States and other countries.

So far, this tactic has appeared to work. During the October through December period of last year, rising American exports largely offset the decline in domestic real estate activity, thereby keeping our broader economy above water.

But there were consequences. As the value of the U.S. dollar relative to other currencies continued to sink, imported goods prices began to rise. The most visible example was the cost of oil.

Oil prices are extremely sensitive to the value of our greenback because the global price of oil is quoted in U.S. dollars.

As recently as the end of 2002, one American dollar was equal to one European euro. But as America's federal budget deficit began to rapidly rise, Congress decided to borrow the required money which forced our U.S. Treasury Department to issue hundreds of billions of dollars in new IOUs. The result was a rise in inflation.

As each American dollar lost buying power, adjustments had to be made. Foreign exchange traders boosted the value of the euro currency to the point where it now only takes a bit more than 60 euro cents to buy an American dollar.

While this development has been great for our exporters by lowering the relative cost of our products sold overseas, it has had the opposite effect when it comes to the price of oil.

Due to dramatically rising oil demand from China, India and other rapidly developing countries, oil prices rose from $35 per barrel at the start of 2003 to $115 this April. The rise into triple digits is an American phenomenon. In the euro currency, a barrel of oil is closer to $70. In other words, if our greenback had remained at parity with the euro through avoidance of deficit spending and the maintenance of a stable interest rate policy, the pump price of regular gasoline may have remained closer to $2 per gallon than the recent $3.40 national average.

But the Federal Reserve's easy money policy has put us in a jam. When taking core inflation (excluding food and energy prices) into account, current short-term interest rates are below zero. For instance, the two-year Treasury note was recently trading near 2.0 percent. If core consumer inflation is running at 2.4 percent, the "real" rate of return on a bank savings account is minus 0.4 percent. In other words, the saved money with interest is not keeping pace with the cost of living.

But the other worrisome trend is that American fiscal and monetary policy is leading to an embedded increase in global price pressures. Simply put, America is exporting inflation. This is most readily seen in the price of agricultural commodities. A recent World Bank estimate put the spike in worldwide food prices at 80 percent in the past three years.

Therefore, it's not only American consumers who are facing significantly higher costs at the supermarket. And the global food price spiral could lead to political instability in countries where the majority of people live below the poverty line.

Federal Reserve officials are beginning to feel pressure from respected economists and financial market participants to bring an end to the ultra-low interest rate policy. If the Fed fails to respond, bond market traders may take matters into their own hands and push Treasury yields higher. When and if that happens, the move could be sudden. And mortgage rates almost certainly will zoom higher too.

As we move into the new week, here are what some key indicators are telling us. A plus (+) sign means the category is on the side of lower interest rates, a minus (-) sign means the forecast is for higher rates, and a zero (0) means the item is giving a neutral reading.