Inflation makes a comeback

Economic growth, Financial Events, Oil markets

Oil prices last week rose to an all-time, inflation-adjusted, high in New York at over $92/bbl. Meanwhile food and commodity prices have continued their upward march. In China, the rate of consumer price inflation hit a decade-high of 6.5% in August. So why are we still seeing rates of around 2% reported in the USA and Europe?

Part of the answer is that China, like other developing countries is less energy-efficient than the West. Equally, as the world’s leading manufacturer, it is first in line to suffer higher prices for metals (the steel industry is expecting a 50% increase in the iron price next year, on top of 145% increases this year). But freight costs get passed straight on to buyers, and the Baltic Index for dry goods such as iron, coal and grains has risen 135% this year alone.

Yet current official Western inflation figures still appear benign. As I commented back in July, central banks such as the US Fed conveniently focus on ‘core’ inflation, that excludes food and energy costs. Similarly, the Bank of England now focuses on consumer price inflation (CPI) instead of retail prices (RPI). What’s in a name, you might ask? 2.1% is the answer. The new CPI registered just 1.8% in September, but the older and more comprehensive RPI clocked in at 3.9%, and is clearly on an upward trend.

Central banks also use ‘hedonics’ as a way of avoiding the hard decisions to raise interest rates when economies are over-heating. But one can’t eat or drive a mobile phone or a laptop, so although these are more powerful today than earlier models, this may not impress union negotiators when they plan tactics for next year’s wage round.

Thus there is a strong argument that investors may have been lulled into a dangerous sense of complacency. A double whammy may be just around the corner. Not only may ‘official’ inflation rates finally start to rise, just as the housing-dominated economies are slowing sharply. But chemical companies’ earnings may also suffer from margin compression if, as seems very possible, consumers prove less willing to accept the latest round of price increases.

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