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INFLATION, for so long on the backburner while the world battled fears of a double-dip recession, is back on the agenda.
With oil and food prices rising, economic policy makers are forced to look the inflation bogeyman in the eye again.
The oil price, predicted to breach $100/barrel, will at that level be about three times the low reached in December 2008, in the aftermath of the collapse of Lehman Brothers and the global gloom that descended on the world then.
On food prices, the United Nations sounded the alarm this month, pointing out that prices were at record levels. The year-on-year increase was more than 30%, although some products, notably wheat, shot up by much more than that.
European Central Bank (ECB) head Jean-Claude Trichet earlier this month warned that eurozone inflation may rise further in coming months, largely as a result of higher energy costs.
Price increases should then begin to fall back towards the end of the year, the ECB president said. He said inflation was likely to stay above 2% until falling back towards the end of the year. The bank’s inflation target is to keep price rises below, but close to, 2%. Inflation in the eurozone currently stands at 2.2%.
The ECB's view that prices will return towards the target in the medium term helps to explain its decision to keep rates on hold at 1% - for the 20th month in a row.
Concern over China's inflation woes
Nevertheless, the markets took Trichet’s comments as a sign that the ECB would be ready to raise rates if inflation didn't behave as forecast. This factor is one of the reasons behind the rally in the euro, which has defied gravity despite ongoing concerns about sovereign debt crises in the eurozone periphery.
However, it's difficult to envisage the ECB hiking interest rates while the possibility of sovereign debt crises remains strong. Should inflation behave differently from the path envisaged by Trichet, the ECB will face a major dilemma.
In the United Kingdom, inflation jumped to its highest level in eight months in December, driven by higher food and energy costs. The annual rate of consumer price inflation rose from 3.3% to 3.7%. Most economists had expected inflation to remain unchanged.
The Financial Times reported that the "high" inflation rate was "adding to pressure on the Bank of England to raise interest rates". For reasons similar to those outlined by Trichet, namely that the breach of the 2% target is temporary, the bank won't necessarily act.
This is especially the case because of the deep austerity programme introduced by the coalition government in Britain. But some analysts are saying that inflation could reach 4% in the UK this year.
In the US, though US consumer inflation was also pushed higher due to pricier petrol in December, core inflation was well behaved.
Core inflation excludes volatile food and energy prices, and is the most important figure for the US Federal Reserve. The Fed has promised to keep interest rates low "for an extended period of time".
Where inflation is more of a worry is in Asia, excluding Japan. Australia, India and South Korea have all raised interest rates in recent months. In China, the authorities are facing a serious inflation problem. China's inflation woes will be one of the major investment themes of 2011.
No reason for rand panic
Having reached 5% in November, inflation in China eased back to 4.6% in December – still regarded as too high. The authorities are using a range of measures to cool the economy, including price controls.
They lifted banks' required reserve ratio – the amount of cash that the banks have to hold against their deposits – as a means to quell credit demand. They have also slightly raised interest rates, and can be expected to do so again. But the Chinese rely more on the banks' required reserve ratio to keep credit demand down than it does on interest rates.
What does all this mean for SA? Aggressive action by China to quell inflation could see a move out of risky assets, like those in SA, and into the dollar.
Rand Merchant Bank says rising inflation concerns – particularly in China and the UK – have brought forward expectations of interest rate hikes. This is contributing to a generalised sell-off of emerging market bonds.
Most of the selling of SA assets came in December, but January is turning out to be another bad month, with R7bn sold to date (compared with R15bn in sales in December).
All this could possibly be bad news for the rand, and explains its recent foray above R7/$. However, there's no reason for panic, especially if the euro continues as strong as it has been. The rand won't move too far out of step with the euro. And, as our oil imports are in dollars, this means a lid is kept on petrol price increases.
But Citigroup says the disinflationary impact of the rand is probably peaking. The bank says inflation is past its cyclical lows and will rise back above 5% in late 2011 and 2012. The Reserve Bank also expects inflation to average 5.3% in 2012, after 4.6% in 2011.
SA is helped by the fact that it has a maize surplus, and also by the Competition Commission's crackdown on bread companies. However, SA's reprieve from high food prices won't last forever. All over the world, the inflation bogeyman is rearing its head.
- Fin24
