Tuesday, May 18, 2010

What Inflation?

This week marks the time of the month that the inflationists come out in full-force as a slew of CPI data is forthcoming from around the globe.  Today, data from the EU and the UK show that consumer prices are moving slightly higher, though there are no signs that policy-makers are ready to move on rates in either of those regions any time soon.In fact, both of these governments are hoping to encourage some inflation to get their economies moving again.  The problem with inflation is that it is a stealth tax on consumers.  Nevertheless governments LOVE inflation as it allow them to repay debt with less valuable currency.
Today in the US, PPI figures came in less than expected and tomorrow brings the US CPI data, followed by Canada’s reading on Friday.   At this point, with all of the global economic uncertainty in the markets, combating inflation is becoming a more distant thought on the minds of policy makers.  Outside of an extraordinarily high reading in either country, I don’t expect it to influence policy one way or the other.  Although the market is anticipating a rate hike in Canada in June so that number could hold some more weight.
So today we are seeing some mild risk appetite, though the Aussie is lower as a result of the minutes from its rate policy meeting, and in the EU, Greece received its first bailout payment of roughly $18 billion.
In the forex market:
Aussie (AUD):  The Aussie is lower as the minutes of its rate policy meeting were released overnight showing that monetary policy is “well placed� after previous hikes according to the RBA.  Right now, the major debate for world economies is weighing the threat of inflation vs. the EU debt crisis.  I suspect central banks may err on the side of caution and stronger economies may put up with inflation until they are convinced that the EU is economically stable.  This greatly reduces the chance of a rate hike at the next meeting in June.  The Aussie is near three-month lows vs. USD.
Loonie (CAD):  The Loonie is higher today on risk appetite as well as the fact that the price of oil has halted its previous decline.  Oil traded higher to just over $72 after a two-week sell-off, but is now at 71.75.  The market still favors a rate hike in Canada, and Friday’s CPI figure will either confirm or refute that view.  The inflation vs. debt crisis is on the mind of central bankers, but Canada has extremely low rates, some 4% less than Australia so they have more room to hike.
Kiwi (NZD):  Producer Input Prices came in higher than expected at 1.3% showing signs that higher costs may suggest that the mid-year rate hike is still on target.  The Kiwi is the biggest gainer this morning.
Euro (EUR):  German economic sentiment figures came in lower than expected as the Greek debt crisis caused consternation in the largest manufacturing country in the EU.  In addition, CPI came in at a .5% increase vs. a .4% expectation showing signs that inflation may be held in check.  Right now, inflation is the last thing on the minds of ECB policy makers as the far greater threat of sovereign default reigns supreme.   The Euro is mostly higher.
Pound (GBP):   The Pound is also slightly higher as CPI figures came in higher than expected at .6% vs. an expectation of .4%.  Again, like the EU, debt service is currently trumping the threat of inflation in the UK, and BOE Governor King downplayed the surge as “temporary� as the UK is about to embark on its own budget cutting measures.
Dollar (USD):   The Dollar is low on risk-taking as well as the fact that US PPI figures showed a decrease of .1% vs. an expectation of an increase of .1%.  In addition, while US housing starts were higher, building permits were much lower than expected showing signs that the housing market may still be on shaky ground.  It appears as though the expiration of the first-time homebuyer credit may be responsible for the pick-up in starts, though the lower building permits show a lack of future construction.
Yen (JPY):   The Yen is lower on risk appetite despite the fact that consumer sentiment rose to its highest levels since 2007.  This comes as a result of the export-led recovery which seems to be taking place.  However, low interest rates still keep the Yen as a safe haven currency and the primary funder of carry trades.  This Friday’s interest rate decision shouldn’t change that.  Thursday brings the GDP figures which are expected to be in line with estimates.
Governments and central banks LOVE inflation because it allows them to repay debts with a less valuable currency.  This is known as “inflating the debt away�.  And with all of the debt floating around out there, you can see why they are trying to encourage it.  However, for consumers, inflation acts as a stealth tax as the cost of everything goes higher.  That’s why here in the US, they give you the reading “ex food and energy� to falsely show what’ going on in the economy.  After all, who cares if milk prices or electricity prices are going higher if the cost of the new iPad is going lower!
Well, this is a simplistic and somewhat skeptical view of central banks and government, but if you really think about it, it makes sense.  So that’s why in the UK they are talking down inflation as “temporary�.
Here in the US, they don’t need to talk down inflation as signs of deflation still persist despite all of the government and US Fed-led attempts to keep prices higher.
What this tells me is that we are still on fragile economic footing and that central bankers have no plans to raise rates anytime soon.  So keep an eye on your currency and a keen eye on prices of things you use daily, as you can no longer count on the government to do that for you!
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