Co-written with other RGE Lead Analysts.
In Greg Ip’s words, “Two fears hang over the U.S. economy: wrenching recession and spiraling inflation”. As reiterated in Bernanke’s recent testimony the Fed’s main focus is growth and financial stability. While the Fed’s base scenario includes a decline of inflationary pressures in the wake of the lackluster economic outlook, upside risks to inflation have increased in the past month. Long-run inflation expectations remain fairly anchored – somewhat above 2% – though they have moved up recently and threaten to become unmoored by soaring prices in oil, industrial metals and agricultural commodity markets. The price of oil reached $103.95 on Monday while a range of other commodities, including corn, rice and soybeans, hit record levels before plunging again – the most in almost six weeks – on Tuesday. High commodity prices are forcing consumers to divert more of the household budget towards energy goods and services. What are the risks of stagflation in the U.S.? Will a recession tame price growth? Take a look at: “US Inflation Developments: Percolating” and “Fed Interest Rate Path: How Low Will Ben Go and What’s the Next Step?”
The coincidence of worldwide inflation scare and signs of U.S. recession and global growth slowdown have revived the 1970s stagflation specter. Important differences exist though such as benign wage pressures, the demand-driven nature of the current slow-motion commodities boom, central bank commitment to price stability, and the prospect of further housing deflation. NBER economists are in the midst of re-assessing the Great Inflation. Check out: “Commodity Prices vs Recession: Difference Between Now and 1970s Stagflation” and “Retrospective on the Great Inflation: NBER Pre-Conference Papers”
European inflation is at the highest level – 3.4% yoy in February – since the introduction of the common currency. Inflation might stay above the ECB’s 2% target for a ninth year. The ECB will meet Thursday to decide whether to raise or lower the benchmark refi rate it has left unchanged since last June. Take a look at: “Inflation in the Eurozone Steps Out of the ECB Comfort Zone” and “ECB Still in Wait-and-See: Risks to Growth Increasing”
Chinese inflation climbed to 7.1% in January, the highest in 11 years. Food prices still account for the lion’s share of consumer price rises, but rising producer prices indicate that more inflationary pressures may be in the pipeline. So far China has relied on price controls and lending curbs in its inflation fighting but money and loan growth reaccelerated in January. With increases in prices of a broader group of inputs, China could now be exporting inflation not deflation. See “How Should China Respond to Inflationary Pressures?”, “Chinese Inflation Dynamics: How Much Will Be Passed On to Export Prices?” and “Impact of Globalization on Inflation: The Chinese Effect”
The dollar peggers (implicit or explicit) in the Middle East, continue to struggle between inflation and Fed easing. After recovering from a dreadful 2005-2006 stock market bubble and crash, the GCC risks another asset bubble – this time in real estate – as oil revenues and low real interest rates support non-oil diversification projects that involve massive construction and imports of foreign labor that drive up domestic demand. At the same time, CPI inflation is surging: Saudi Arabia, has seen its annual inflation rise from 1% in 2003 to 7% in January, losing its crown as the lowest-inflation member of the GCC to dollar de-pegger Kuwait. The U.S. dollar’s deepening decline has tested the resolve of policymakers to uphold the dollar peg. Read: “Will the GCC Follow Kuwait and Revalue or Depeg From the Dollar?”, “Risk of GCC Asset Bubbles and the Policy Options” and “GCC Inflation: Imported Goods, Labor Not So Cheap Anymore”
Shouldn’t inflation in Japan be good news? After a decade-long fight against deflation, Japanese prices are finally rising at their fastest pace in twenty years. The problem is rising energy and raw material costs, rather than growing demand, are the inflation drivers. This could further depress Japan’s already anemic consumer spending. See: “Japan’s Inflation Irony: Price Rises Driven By Energy Costs, Not Growing Demand”
Finally, Canadian inflation has trended down from a stronger loonie’s purchasing power meaning that the Bank of Canada doesn’t have to choose between growth and inflation. The IMF and others have downgraded Canada’s both growth and inflation outlooks this year. Exchange rate gains, softening housing prices, weak export and manufacturing sectors may keep core CPI – 1.4% in January – below the BoC’s 2% target for much of 2008. Check out: “Bank of Canada Cuts 50bps: Where Will They Stop?” and “Strong Loonie, GST Revisions Having a Moderating Effect on Inflation?”
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