Tuesday, June 17, 2008

What Inflation?

I have a mixed feeling about the possibility of future inflation. On one hand, commodity prices are still increasing. Oil is touching new highs nearly every day and agricultural prices are spiking thanks for floods in Iowa. On the other side, there's an old adage: "nothing cures high prices like high prices." In other words, high prices (in and of themselves) create incentives for people to purchase cheaper substitutes (if they exist) or to produce more of the high-priced good in an attempt to make money.

So, with the two stories listed below the question to ask is, "are these the type of price spikes that will create incentives for lower prices down the road?"

From Bloomberg:

U.K. inflation reached the highest since at least 1997 in May, and Bank of England Governor Mervyn King predicted it will exceed 4 percent later this year, adding to speculation that the economy will fall into a recession.

The Monetary Policy Committee ``is concerned about the present and prospective period of above-target inflation,'' King wrote in a letter to the government, after the Office for National Statistics said consumer prices climbed 3.3 percent from a year earlier last month. ``The path of bank rate that will be necessary to meet the 2 percent target is uncertain.''


Policy makers ``are going to sit on their hands for the time being since there's not really much they can do for the moment,'' said George Buckley, chief U.K. economist at Deutsche Bank AG in London. ``They need to see what the economy does first.''

From Bloomberg:

European inflation accelerated to the highest in 16 years last month as food and energy costs soared, intensifying what finance ministers from the world's richest nations said is becoming a ``more complicated'' dilemma.

The inflation rate in the euro area rose to 3.7 percent, the highest since June 1992, from 3.3 percent in April, the European Union's statistics office in Luxembourg said today. The rate for May is higher than the 3.6 percent estimate published on May 30.

Soaring commodity prices have pushed up costs for companies and consumers and at the same time are posing a ``serious challenge'' to economic growth, officials from the Group of Eight nations said yesterday after a meeting in Japan. European Central Bank President Jean-Claude Trichet this month said the ECB may raise its benchmark interest rate a quarter point in July, signaling he is setting aside concerns about the economy's expansion to combat inflation.

With inflation accelerating ``it becomes increasingly difficult to argue against an ECB hike in July,'' said Carsten Brzeski, an economist at ING Group in Brussels. ``However, we still believe that a July rate hike would be a one-off, mainly to flaunt the ECB's willingness to fight any second-round effects.''