Financial Daily from THE HINDU group of publications
Wednesday, Oct 19, 2005
Financial Daily from THE HINDU group of publications Wednesday, Oct 19, 2005 |
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Money & Banking
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Interest Rates Industry & Economy - Economy Columns - Financial Scan The dilemma of inflation-interest S. Balakrishnan
FOR the first time in many years, the inflation threat looks real. Heading the list of culprits is the price of oil, which has escalated six-fold from its low of $10 in the late 1990s to well over $60 today. Prices of metals (steel, copper) and agris have also been on a tear. The broad-based CRB Commodity Index is in the region of 330, having risen from below 200 when inflation was at its lowest. Other data do confirm that inflation is up. The US's headline CPI numbers show prices increasing north of 0.3 per cent practically every month. But with the food and energy components removed, the figures are tamer - generally 0.1 per cent and occasionally 0.2 per cent. The story is repeated with wholesale prices, which are comparatively well-behaved, ex-food and energy. However, a degree of pass-through of commodity costs seems to be occurring in the manufacturing sector, with the price paid index of the ISM surveys surging in recent results. The European Central Bank continues to talk tough on inflation and will raise interest rates regardless of the overall economic situation, if it sustains over its target of 2 per cent. The Bank of Japan thinking that deflation will at last be put to rest next year portends an end to its zero interest rate policy. The outlook for inflation is clouded by the very factor which makes it a risk — high oil prices. If overall economic activity remains unaffected by rising oil, there is a significant probability of the inflation indices moving up. The threat diminishes considerably if consumers' pocketbooks are hurt so much by fuel bills that they have to cut back on other spending. In the latter case, the risk is not inflation but an economic slowdown. Mr Alan Greenspan, Chairman of the US Federal Reserve, is perfectly aware of the dual possibility. In recent speeches, he has been blowing hot and cold on inflation and interest rates. The minutes of the last Federal Open Market Committee meeting show that all members barring one voted in favour of continuance of the policy of gradually increasing interest rates. Hurricane Katrina did not herald a slowdown, they felt. However, there is no mistaking the weakening trend of recent data on the American economy. But in the Fed's calculation, this is offset by rising Federal Government spending. Going soft on interest rates amidst higher fiscal deficits is obviously not a sound policy. Paradoxically, the surest sign of the future will be falling energy prices. That will spur consumer and business confidence and lead to higher economic activity and inflation risk. Then one can be certain that interest rates will go up.
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