Inflation virus is spreading

Inflation virus is spreading

Rising metal prices are an early indicator that inflation could spread beyond food articles and make many consumer goods more expensive.

Most economists say that food inflation is a result of poor harvests and low stocks, factors that are beyond the control of monetary policy. Higher prices of cars and fridges are, however, quite another matter. Interest rates may need to be increased to tackle this form of inflation, perhaps not immediately, but maybe a few months down the line. India’s wholesale price inflation could be close to 8% by the middle of 2010.

Prices of industrial metals bounced off their recession-stricken lows in 2009. Copper, lead and zinc prices doubled. Aluminium was up 50%. Yet, it is important to understand that metal prices are still substantially below their peak levels of 2008, just before the financial crisis. The scope for further price appreciation is substantial.

Three factors have driven metal prices higher in 2009: the economic recovery, stockpiling by China and excessively loose monetary policies the world over. Much thus depends on how these parameters move in the coming 12 months.

Most forecasts suggest that the economic recovery will gather steam in 2010, though the possibility of a double-dip recession cannot be ruled out. The strength of the recovery will determine how demand for metals grows.

What China will do will always be a mystery. Its strategically smart decision to build a stockpile of metals—especially copper—when prices were at rock bottom was far-sighted and it is hard to guess whether it will draw down these inventories this year.

The third parameter is the easiest to analyse right now. Central banks across the world have quite clearly signalled that they will start removing monetary accommodation in 2010, even though they do not send interest rates several notches higher.

However, this third macro factor could be the least important driver of metal prices this year. Far more will depend on demand for metals from various industries and the pace at which China either uses up or adds to its inventory pile. The initial indications are that higher metal prices will feed inflationary pressures this year.

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