Is inflation stickier than markets think?
Money Week has a story written by Niels Jensen, CEP at Absolute Return Partners. He claims that inflation will be more difficult to deal with than markets assume. Take a look:
Copernic tags:
inflation prices economy “oil prices” bank globalisation policy energy reasons government Europe “inflation debate” “monetary policy” rise “Phillips curve”
Copernic 25% summary of Jensen’s article:
The inflation debate is raging on either side of the Atlantic at the moment.
Is the current spike in consumer price inflation (CPI) temporary or longer-lasting?
The U.S. Federal Reserve Bank has stated unequivocally that the current state of affairs is not likely to be long-lasting.
They expect the headline rate of inflation to come back down again over the course of the next year or so.
Central banks in Europe and Asia have taken a somewhat different view; hence investors in those markets should expect interest rates to go up for a while longer — at least in the short term.
But the Fed could be terribly wrong in their analysis.
This is going to be one of the most important calls you have to make over the next year or two — so much rides on the outcome.
“Nature has given enough to meet man’s need but not enough to meet man’s greed.”
This month we will be taking a look at what is in store as far as inflation is concerned.
A prominent European economist invited to the symposium had the audacity to stand up and suggest that the Fed governors have lost the plot (well, he didn’t quite say it that way but based on the press reports from the meeting, that’s probably what he meant to say).
The economist in question was none less than Charles Bean, chief economist at the Bank of England, and we will revert to his words of wisdom a little bit later.
First and foremost, inflation has a major impact on how long-dated bonds are priced (one could argue that inflation expectations are in fact more important than actual inflation but let’s not be small-minded here).
Secondly, the level of inflation determines our purchasing power.
Thirdly, and very importantly from the government’s point of view, the rate of inflation is used to regulate a large number of payments from the public sector to the private sector (such as social security benefits).
One could therefore argue that governments all over the world have a vested interest in keeping the publicised inflation number down, because it will keep the cost to the government down.
In the last couple of years, however, inflation has been creeping up again, assisted by the dramatic rise in energy and other commodity prices.
A good account of the reasons behind the general fall in inflation can be found in a research paper produced by the Bank for International Settlements, a copy of which is available in our research library on www.arpllp.com.
After all, if lower inflation was primarily the result of a change in monetary policy, one would expect the effect to be fairly evenly spread across all sectors in the economy.
Also, the biggest change in monetary policy over the past decade or so has been the adoption of inflation targeting amongst central banks — with the noticeable exception of the U.S. Federal Reserve Bank which has not yet embraced this novel approach.
However, there is no proof whatsoever that the U.S. Fed has been any less successful than their European or Asian peers in the conduction of monetary policy.
All this made perfect sense until oil prices started to play havoc with inflation rates.
The vast majority support the view (which has been repeatedly communicated by the Fed) that the rise in inflation is temporary and will soon be reversed again.
- The deflationary force of globalisation will eventually dominate the inflationary force of high energy prices.
According to our friends at Morgan Stanley, Asian export prices are on the rise again after being under pressure for a number of years.
Asia in general, and China in particular, has been a big exporter of deflation in recent years.
Geopolitical risk is much higher today than at any point in the last decade.
Any signs of the higher borrowing costs taking their toll on borrowers’ appetite for risk are few and far between, at least as far as Europe is concerned.
The Phillips curve describes the interaction between the rate of inflation and the rate of unemployment.
Moving production facilities to low cost countries you can do once – perhaps twice (from, say, China to Bangladesh or Vietnam).