SCOREBOARD: Inflation omens

It's unfortunate that following the rolling waves of ineptitude and hysteria, market participants, politicians and policy makers have lost their focus and ability to see clearly.

In my opinion, people are far too blas about what is likely to be a key global problem over the next five to ten years. No, it's not weak growth and no, it's not debt. These are problems that are widely misunderstood and exaggerated.

Also widely misunderstood, but downplayed and far more insidious, is the real threat – and that is inflation. Two key data releases were issued last night and both were markedly stronger than expected. A bit of a pattern as it turns out.

In the UK, consumer prices rose by 0.6 per cent in September, which was stronger than the 0.4 per cent expectation to now stand 5.2 per cent higher annually. Core inflation is 3.3 per cent higher annually and inflation, assuming no change in tax rates, is 3.5 per cent higher.

Embarrassingly, after every release economists and policy makers trundle themselves out to confidently express that inflation will come down sharply next year and fall to within the target band. This must be for comic relief more than anything because these same people have been saying that every year now – for years.

Indeed the Bank of England, in early 2010, forecast inflation to be below 2 per cent by now. By late 2010, the BoE forecast inflation to be around the 3 per cent mark and yet here we are with inflation over 5 per cent. There is quite obviously a small problem with the bank's forecasting ability and their models are obviously not working.

Across the sea, Bernanke reckons that inflation has moderated – and that's despite actual inflation data showing that inflation has accelerated. Clearly he has stopped looking at economic statistics and just reads the clouds for his economic data, or perhaps chicken entrails. So producer prices last night blitzed expectations of a 0.2 per cent lift, instead rising by 0.8 per cent to be almost 7 per cent higher annually.

This is the strongest growth rate in three years and is more than double the average annual rate over the last decade. Core PPI rose by 0.2 per cent and is 2.5 per cent higher annually (the highest in two years and well above the average of 1.7 per cent). But as I've highlighted in the past, core inflation is of limited use in this environment and is trending up in any case.

Now we know policy makers, especially in the UK and the US, are not going to respond to inflation. Furthermore, the fact the Fed is set to leave rates lower forever will also constrain the ability of policy makers elsewhere to deal with inflation. Inflation is here, and while it might moderate a bit over 2012, isn't going away. Investors and market participants need to be aware of this problem and note that when it does eventually come back on the radar it will do so swiftly and aggressively.

In the short to medium term though, events in Europe will dominate. The latest speculation is that France and Germany have hit a deal to leverage the EFSF up. Citing no sources, press suggest that the EFSF would promise to cover the first 20-30 per cent of any losses on Spanish or Italian bonds.

This plan seems to have offset negative sentiment that was building yesterday after one of the ratings agencies suggested France was at risk of losing its AAA rating. Indeed, European stocks were generally weaker (although Dax was up 0.3 per cent) on that news and some suggestion, according to the news wires, that growth in China at 9.1 per cent is weak – I beg to differ. Whatever the case, the FTSE was off 0.5 per cent led down by basic materials and financials, while the CAC was 0.8 per cent weaker.

On Wall Street, stocks managed a strong bid following this supposed boost the EFSF and the S&P500 closed up just over 2 per cent (1225). Financial surged over 4 per cent, (profit result from BAML), but energy and industrials were also key outperformers (WTI was up 2.8 per cent to $88.8, while Brent was 1.3 per cent higher ($111.6). The Dow was otherwise 180 points higher (11577), the Nasdaq rose 1.6 per cent (2657) while for Australia, the SPI was 1.7 per cent higher (4255).

In the forex space, Australian dollar was up 63 pips to 1.0278, euro was down 13 pips to 1.3765 (both on a 2 figure-plus range though), sterling was off 87 pips to 1.5727 while yen was unchanged at 76.84. For commodities elsewhere, gold was off about $10 to $1661, silver was 1.3 per cent higher while copper fell 0.5 per cent.

Finally for debt then, US Treasuries were little changed – yields were modestly lower – although ranges were comparatively wide (12bp on the 10-year and 8bp on the 5). Australian 3s and 10s did little sitting at 96.17 (up 1 tick) and 95.52 (up 4 ticks).

A few other things to note which are of importance. Firstly the Europeans placed a permanent ban on naked CDS positions and have tightened rules and increased transparency on things like short selling bonds, shares and credit . Then the CFTC voted to approve new position limits on a whole bunch of commodities like crude, wheat, metals etc.

Note that these limits won't prevent speculation or investment in commodities per se, so I don't think it'll have much of an effect on the trajectory of commodity prices overall, which will continue to get a boost from zero interest rates, QE and solid growth. But it will prevent concentration.

Other than that, just note the German investor sentiment fell according to the ZEW survey but currently remains very positive. The current situation index fell to 38.4 from 43.6 (average -16). Expectations are sour however with this index down to -48 from -43 and an average of 23).

That's the lot, not much today, and tonight we get US CPI and the Beige Book.

Adam Carr is senior economist at ICAP Australia. See Business Spectator's glossary for definitions of technical terms used in SCOREBOARD articles.

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