Price pressure

Price pressure

The news on the inflation front is not good.

While the world’s attention over these past few months has been focused on what central banks can do to tackle the global credit crisis and keep economic growth on track, inflation has reared its ugly head in many important economies. Rising prices will restrict the ability of central banks to cut interest rates and pump more money into the financial markets. Stock market investors will need to digest this new reality.

Consumer prices are growing even faster, especially food prices that make up a large part of the monthly expenses of the poorest. Vegetable prices were up 1.5% between the third and fourth weeks of November. At the other end of the consumption spectrum, car manufacturers have said that they will raise prices in 2008.

There are similar inflation pressures building up in other parts of the world. China is now struggling with its highest inflation rate in 11 years. Not too long ago, it was battling deflation. The initial spurt in Chinese inflation was dismissed as a non-issue, since the price indexes were pushed up by rising pork prices. But inflation has seeped into other corners of the Chinese economy since then, which is why its central bank is very clearly trying to cool down an overheated economy by raising interest rates and restricting the ability of banks to lend.

The picture is not any prettier on either side of the Atlantic. Europe had an inflation rate of 3.1% in November, far above the 2% target of the European Central Bank. Germany, the largest economy in that continent, is facing the highest inflation rate in 13 years. Among the European Union states, Latvia’s inflation rate is uncomfortably high at 13.7%. There is a clear inflation battle ahead in Euroland.

And now the US: Here too, prices have shot up. November saw the fastest monthly rise in retail prices (0.8%) in two years. Sclerotic Japan is perhaps the only major economy in the world that has inflation under control; but then its problem is decade-long low growth.

Inflation rates today are nowhere near where they were during earlier episodes of fast-rising prices in the 1970s and 1980s. Also, most of the current price pressures emanate from food and fuel prices. Core inflation, which does not take these two volatile items into account, is more steady. But a consistent rise in fuel and food prices, which is quite likely, will eventually feed demands for wage hikes and push up prices.

Central banks the world over have followed remarkably easy money policies over the past 10 years, as they pumped more and more money into the economy to keep various financial crises at bay. This would ideally have sparked off inflation at once. It didn’t happen partly because China was undercutting everybody else and keeping global prices in check.

That’s no longer the case. China can no longer export deflation to the rest of the world; it is today more likely to export inflation. This is why we believe that the actions of the Chinese central bank have to be watched very closely.

Pessimists believe that we are moving into a new era of double-digit inflation and sluggish growth, a copy of the 1970s stagflation. That is unproven—as yet. But there is little doubt that the inflation numbers announced last week in India, China, Europe and the US take some wind out of the case for ever-lower interest rates.

Are we inching toward an era of stagflation? Write to us at