Inflation demon may yet find more victims

Inflation demon may yet find more victims
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First Published: Wed, Aug 20 2008. 11 19 PM IST

Updated: Wed, Aug 20 2008. 11 19 PM IST
Here is a comforting story, widely believed by investors. The demon Inflation, long thought to be chained to the rock of sound monetary policy, somehow managed to capture the fair maiden Commodity Prices.
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But then a rather shambolic knight, Sir Slow Economy, came to the rescue. Commodity Prices fell into a swoon, Inflation will soon be chained back, and King Central Bank will throw a rate-cutting party.
Commodities have certainly been the main source of inflation. In the US, the overall inflation rate is alarmingly high at 5.6%, but cut out food and energy prices and the rate is a nearly acceptable 2.5%.
The gap between headline and so-called core inflation is wider in poor countries, where commodities account for a higher portion of total consumer spending.
The story advances. Commodity prices have fallen sharply, although most are still higher than a year ago. From the July peak, copper is down 15%, crude oil 25% and corn 30%. The presumed culprit is slower growth. The euro zone, Japan and the UK are all flirting with recession, and Chinese growth has fallen to below double-digit rates.
The next episode is supposed to be a drop in overall inflation. Financial services firm Lehman Brothers Holdings Inc. is calling for US inflation to drop below 2% in 2009 — and pave the way for cuts of 50 basis points, or half a percentage point, in the overnight interest rate.
Sadly, this happy ending could prove no more than a fairly tale. To start, the growth slowdown may end quickly. As yet, overall US gross domestic product has refused to oblige predictions of imminent collapse. And lower commodity prices could help restore higher growth in the euro zone and China — leading to renewed inflationary pressure.
But even if growth slows, the inflationary monster may still roam. Workers are still anxious for higher wages to catch up with higher commodity prices. Will there be money to satisfy them?
Sure, the credit crunch is making lenders more cautious. But workers in strong industries and countries will get some of what they want. And with real interest rates still low and government borrowing set to increase sharply, demon Inflation may yet find other victims.
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First Published: Wed, Aug 20 2008. 11 19 PM IST