Suddenly the spectre of inflation no longer hangs over the world: it’s gone, banished by the reversal in sentiment in commodity and financial markets.
Banished by fears of recession, which were confirmed overnight with Europe contracting in the second quarter, with Germany and France following Italy into a slump.
Oil, copper and gold down, and wheat, corn and soybeans as well it’s been a sea change in sentiment in the past month.
Slowing Europe and Japan suddenly mean the US is not alone, so it’s off into the greenback because you’ll be more protected there.
Europe moved into a real slowdown in the June quarter,with growth contracting by 0.2%, Germany’s economy contracted by 0.5%. France slowed as well, with the economy falling a surprising 0.3% in the quarter.
Growth is still up for the first half after the March quarter saw growth of 0.7%, but the size and speed of the slump was surprising, and emphasised why commodity prices are weakening, along with the euro.
Inflation is supposed to have peaked, or is close to peaking; growth is slowing, and so will price pressures as recession bites.
That’s why the surge in consumer inflation last month in the US came as a complete shock to the markets. Despite the slump in oil and petrol prices from mid-month onwards, and the rise in the value of the US dollar, the CPI surged by a rather large 5.6%, the highest rate since January, 1991 when the first Gulf War was raging.
That compares to an annual 5.1% in the year to June.
The CPI rose 0.8% in July, compared to June when it jumped 1.1%, so there was a small slowing.
But the surprising news had no impact on interest rates, shares or sentiment. oil was still easier, gold fell sharply, losing the gains of the day before and copper was lower.
Higher food, petrol and energy costs were responsible, despite the drop in oil and petrol prices. Those falls are continuing, that’s why economists believe the CPI will drop sharply this month.
Now the older and wiser of those in the market wonder if there’s something more dangerous approaching, along with the slumping global economy: deflation. More of that shortly.
All year long, the debate has raged over whether the world faces a greater risk from resurgent inflation or from a deflation, caused by the credit crunch, to match Japan in the 1990s.
The fall in commodity prices has, for now, convinced the market that we need not worry about inflation.
In the US, the market for government inflation protected bonds (called TIPS) now implies that inflation will average 2.16% over the next decade.
That’s the lowest in five years, but is it just as much an overshoot as the upward drive in commodity prices when they peaked midway through last month?
What is still clear is that inflation is still with us: from the United States, through Europe and Asia, prices are still rising.
Wholesale price inflation is double digit in China (but consumer prices are easing); in the US, Europe and the UK wholesale and consumer price inflation are at levels not seen for more than a decade in some cases.
In Japan this week’s report of a 7.1% jump in wholesale inflation was the steepest rise in 27 years
In the eurozone, the consumer inflation hit 4.0% in July; more than double the European Central Bank’s inflation target of 1%-2%.
Inflation stands at 3.6% in France, at 4.4% in Britain (its highest level for 16 years) and at its highest level for 12 years in Italy at 4.1% and 11 years in Spain where its running at 5.3%.
In Germany inflation hit 3.3%, the highest rate since 1993 and enough to get the old anti-inflationist Bundesbank rolling in its grave.
Inflation hit 4.3% in Norway, Eastern Europe it’s 6.7%, while in India it’s running at nearly 12% and in Japan at 1.9%, the highest for more than a decade.
In some countries such as Argentina there’s doubt about the declared rate (9.3% there) because of changes to the way the government accounts for and reports inflation. In Thailand it’s running at 27% and higher in Egypt
This week China reported a slowing in consumer inflation to 6.3% from 7.1% in June. But core measures which discount food and energy have risen past 2%.
Now the point of this international roll call is to make a point: normally it would be enough to see interest rates rising everywhere: in India, the central bank is tightening policy, but apart from the increase at the start of July by the European Central Bank, central banks are holding back, transfixed in the case of the Fed and with the Bank of England by fears of a downturn and fears about inflation.
So why then are financial markets (even bond markets) suddenly more relaxed about price pressures and galloping into equities and out of oil and commodities?
Relative growth differences between the US, Asia and Europe are the one reason already stated, but the Merrill Lynch’s August fund managers survey provides a second reason.
Big international investors no longer fear inflation.They worry more about recession, which they believe will take care of cost pressures.So does that indeed signal a deflationary period of rapidly falling growth and prices?
Here’s what Merrill Lynch concluded this week:
Fund managers’ fears of inflation have all but evaporated to reach their lowest level since the downturn of late 2001, according to Merrill Lynch’s Survey of Fund Managers for August.
Merrills said a total of 193 fund managers participated in the global survey from 1 August to 7 August, managin
