SCOREBOARD: Inflation irritation

As markets digest the notion of unlimited QE, dark clouds of inflation are building on the horizon.

The risk bid continued on Friday, more so in Europe, as the market went about digesting QE infinity in the US and something not too dissimilar in Europe. I should add there was a run of not-so-shabby data as well which would have helped things along.

In the US for instance, retail sales shot up 0.9 per cent and while much of this was inflation – gasoline and food etc – sales excluding those components still held up well (0.1 per cent) in August after a 0.8 per cent surge the month prior. Fact is consumers are spending.

Similarly, and while industrial production was weaker in the month, falling 1.2 per cent, business sales were solid, rising 0.9 per cent as were inventories which rose about 0.8 per cent. Sales and inventories rising together is a great sign, because it means on the one hand, businesses are selling stuff and two, they expect solid sales to continue which is why they are stocking up. So it’s all good news and more evidence that the elusive US double dip or stall speed growth etc will remain as elusive as ever.

There were some dark clouds though – the dark clouds of inflation. In Europe, the consumer price index rose 0.4 per cent in August to be 2.6 per cent higher over the year. The ECB has an absolute upper bound of 2 per cent recall. In the US, inflation rose at its fastest pace in about 3 years (0.6 per cent) to be 1.7 per cent higher annually – core inflation is 1.9 per cent higher and of course the Fed’s stated comfort zone is 1.7 to 2 per cent (although they prefer the core PCE, this is running at a similar annual rate)

Now these aren’t inflation rates to be panicked about. Of course they’re not. But that’s not to say they're not problematic as some fools would have you believe. These people still probably think the world is gripped by deflation. Nut cases the lot of them. The problem, as I have highlighted before, is that these ‘modest’ inflation outcomes as they are termed, exceed or sit just within stated comfort zones (strict targets in the case of the ECB) at the same time that the economic recovery is supposedly sluggish and with very high unemployment.

You don’t need to be a rocket scientist to realise that if inflation is at, near or above target now, then there is a very good chance inflation will continue to accelerate as the economy recovers. Indeed it is likely.

So my view is unchanged from 2009 – inflation, not deflation will continue, central banks will do nothing about it, reacting only belatedly to bring it down. This of course will result in a prolonged recession at that point. Typically recessions in the modern economic era are caused by policy actions to combat inflation, as I have noted many times in this column over the years.

Now this certainly isn’t the consensus, although it’s only fair to note that the consensus has been wildly incorrect for years. Not even close to being right. Logic, data and economic theory have been swept aside by a large number of economists in this mindless pursuit for lower rates. Yet deflation didn’t materialise, not even disinflation, the US hasn’t double dipped etc etc. None of the stated bogeymen materialised in fact. And still, off we go.

The call for lower rates in Australia is even more insane given our strong broad-based economic growth and low unemployment. Especially as the call relies almost entirely on the appearance of the thus far elusive bogeyman.

The retort from these hare-brained analysts is that neither did hyperinflation eventuate as economists, such as myself, were apparently predicting. Although that is a distortion of the truth as no one was predicting hyperinflation. Just that deflation wouldn’t eventuate, the global economy would recover quickly and we would see an acceleration in inflation – and that is exactly what has happened and the data on Friday night confirms it. But those are the tactics used by these economists – hypocrisy, blatant lying and deception. All to get lower rates. Anything to get lower rates.

At the very least the persistence of inflation during this ‘sluggish recovery should alert investors and I’d be looking to protect against it while it is comparatively cheap. I’ve talked more about the investment implications in my Eureka column though.

The Reserve Bank should be alert to all of this although I have no faith that they are given the aggressive cuts we have seen. We’ll see what Tuesday’s minutes reveal, but the press release following the last meeting was slightly more dovish. Admittedly a lot has happened since then. Certainly financial markets are more relaxed given the world’s major central banks are printing and the news flow has been more positive. Recall my view that the board determines policy based on the news flow of the day.

As unkind as that sounds, there is no way to rationalise the decisions they have made while the economy has accelerated so sharply. The RBA board reacts to ‘bogeymen’, that much is clear – remember the insurance cuts. On that basis and if the news flow remains positive and the risk bid holds up I don’t think they could really justify another cut.

Outside of the RBA there isn’t much for Australia – car sales today and a speech from the assistant RBA governor on "Structural change and the rise of Asia” on Wednesday at 1050 AEST.

On the global front I don’t think there is too much data that will rock the world, some manufacturing survey and some housing data which I’ll go through on the day of release.

Same-same for Europe.

So that’s about it then, hope you have a great day….

Adam Carr is a leading market economist. See Business Spectator's glossary for definitions of technical terms used in SCOREBOARD articles.

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