We know that inflation is a big issue in Australia, but in the US it is making a return to the centre of the economic debate as the credit crunch turmoil eases and the battered US economy staggers on.
The Fed made sure the market realised inflation was still a concern in its statement after the April 30 meeting when it cut its key interest rate by 0.25 to 2%.
Since that meeting world oil prices have surged past $US123 a barrel to remind everyone that inflation is primarily coming from it, and from rising food prices. The price topped $US122 on Tuesday and rose further overnight, despite better than forecast oil inventories for the US this week.
In fact oil prices are up around $US10 to $US13 a barrel in the past 10 days and around $US9 in the past week.
A combination of factors are helping the weaker tone to the US dollar: problems in Nigeria and concerns about production from some major producers like Mexico, Russia and Nigeria.
Rice prices rose for a fourth day yesterday on the back of the terrible devastation caused by the cyclone that struck Burma. Wheat and corn rose in the US to break a recent weak trend.
All in all inflation seems to be moving back into the mainstream economic argument in the US.
Inflation wasn’t mentioned at all in a speech Monday night by Fed chairman, Ben Bernanke, who concentrated on the damage, actual and potential, that mortgage delinquencies and foreclosures could and are causing to the US economy and US community.
But late Tuesday night, US time, Kansas City Federal Reserve Bank President, Thomas Hoenig made sure inflation returned to centre stage by warning in a speech that "serious” inflation pressures may compel the central bank to increase interest rates.
That saw the US dollar reverse the nasty bout of weakness seen Monday and Tuesday and rise against the euro.
He said in a speech in Denver that "There is a significant risk that higher inflation will become embedded in the economy and require significant monetary policy tightening to reduce it”.
He warned that US consumers are gaining an "inflation psychology to an extent that I have not seen since the 1970s and early 1980s".
That’s a view that has been expressed here in Australia and in Europe where the central bank and the Bank of England are considered unlikely to drop rates (although the UK central bank could surprise as more bad news emerges about housing and retailing).
But Hoenig’s warning will add to speculation among investors that the Fed has finished its rate cutting after seven reductions since September when the credit crunch starting being felt.
Hoenig isn’t a voting member of the Fed’s main body, the Open Market Committee for 2008. He said in his speech that "A sharp slowdown in growth has put the economy at the brink of a recession while, at the same time, rising commodity prices have caused inflation pressures to rise considerably.
"The current accommodative stance should be sufficient to cushion the economy from a deeper slowdown. As the economy recovers and credit conditions improve, however, it will be necessary for the Federal Reserve to remove the policy accommodation in a timely manner.”
US commentators pointed out that Hoenig dissented from a cut in rates last on October 31 because of concerns about inflation. Dallas Fed President Richard Fisher and Philadelphia’s Charles Plosser have both voted against the past two rate cuts for similar reasons.
Hoenig said that the current economic weakness can be largely attributed to slumping housing construction and higher energy prices, which reduced consumer and business spending and "Financial market disruptions, while noteworthy, are not the major story behind the recent weakness, energy price increases and housing dominate this slowdown".’
Hoenig also said in his speech that the combination of slowing growth and inflation is "troublesome". "Some would dismiss these rising inflationary pressures as temporary. I believe they are more serious.”
The Federal Reserve’s preferred measure of inflation, which strips out food and fuel prices, rose 2.1% in the year to March compared to 12 months. Including fuel and food and prices it climbed 3.2% for the fifth straight month of price pressures above 3%.
Over the past year oil has risen from around $US62 a barrel, to more than $US120. Futures prices hit $US122.76 a barrel in New York Tuesday night before easing to around $US121.84. An influential Goldman Sachs oil analyst forecast that oil could go to $US200 a barrel (and to be fair, a Citigroup analyst said that could happen, as could oil dropping to $US40 a barrel).
The US Energy Department also increased its 2008 forecast for oil and petrol prices, and forecast the high prices would cut US demand for the commodity by more than previous forecast.
The latest Goldman Sachs prediction that oil prices could rise to $US150 to $US200 within two years seemed to motivate much of yesterday’s buying, but further armed attacks in Nigeria, and the falling dollar played their part in sending traders after oil supplies.
As well there are increasing concerns about declining crude production in Mexico and Russia, while the strife in Nigeria continues to cut its output.
The Goldman Sachs analyst, Arjun Murti has some form in getting oil calls right: in April 2005 he predicted the oil market was in the early stages of an unprecedented rally that would send prices from a then-record of about $US57 a barrel to $US105. He did add in his latest report that the surge in prices to $US150 to $US200 a barrel would eventually cause demand and the price to fall sharply.
In Washington the US Energy Department’s Energy Information Administration fore
