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 News from Around the Americas | February 2008 
Global Inflation Climbs to Historic Levels
 Kevin Plumberg & Steven C. Johnson - Reuters
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| | Asia may be in the best position because central banks there have the most room to let their relatively weak currencies rise to counter price pressures, making them attractive to investors. | | |
While the world frets about a possible U.S. recession, global inflation has quietly climbed to historic levels, confronting policy makers with tough choices that could end up hurting the euro and lifting Asian currencies.
The dollar, meanwhile, could stabilize after two consecutive years of steep declines, caught between strength against European currencies and weakness versus Asia.
The dollar's descent accelerated, particularly against the euro, in the second half of 2007 as falling housing prices, volatile equity markets and slack consumer spending pointed to a possible recession in the United States. Now, concerns about growth have moved across the Atlantic.
The euro fell 2 percent against the dollar last week, the biggest fall since June 2006, as markets began betting that the European Central Bank would have to cut its own borrowing costs, even with euro-zone inflation at unprecedented levels.
In China, officials are dealing with a different dilemma: keeping growth solid and inflation contained by slowly allowing the yuan to strengthen. Government data there show that consumer inflation remains near an 11-year high.
At a time when global growth is slowing and prices are rising, a strengthening currency can help protect consumers by increasing their buying power.
The conventional wisdom says countries with relatively weak currencies will have an easier time battling inflation in 2008 if growth remains stable, because there is more room for them to rise.
Countries and areas with strong currencies, like the euro, will most likely have fewer anti-inflation tools at their disposal because higher interest rates will risk choking off growth by pushing the currency even higher and crimping exports.
Asia may be in the best position because central banks there have the most room to let their relatively weak currencies rise to counter price pressures, making them attractive to investors.
"I see the United States as the deflationary epicenter of the world because of the housing issue and everything that's associated with that," said Martin Schulz, director of international equities with Allegiant Asset Management Group in Cleveland. "I see the reflationary forces in the world coming from Asia."
With continuing solid growth in the global economy, hardly any region in the world has not encountered higher prices on everything from cooking oil and gasoline to education and health care.
Inflation is at 16-year highs in Saudi Arabia, a 14-year high in Switzerland, a 25-year high in Singapore. And the list goes on and on.
Australia's central bank bluntly warned Monday that it would need to raise interest rates further to contain inflation, even though it had lowered its outlook for economic growth.
"In previous booms, we've had inflation causing central banks to tighten and that brought growth to a halt," said Gabriel Stein, an economist with Lombard Street Research in London. "This time, we have weakness from another source that in some places stops central banks from tightening, so there is a risk of embedding inflation expectations."
In the United States, the Federal Reserve is a case in point. One of its main goals is to restrain inflation expectations, because they can influence how people behave in the marketplace, which in turn has an impact on future inflation.
But to keep the economy from tipping into recession, the Fed has slashed benchmark interest rates by two and a quarter percentage points since mid-September despite signs of elevated inflation.
A gauge of inflation expectations tracked by the Federal Reserve Bank of Cleveland rose in February to its highest since May 2004, complicating the Fed's job. Lower interest rates have also weakened the dollar, but analysts said the trend might not continue.
"All things being equal, for the United States, the Fed cutting rates contributed to a weaker dollar," said Richard Clarida, a professor of international economics at Columbia University and global strategic adviser with Pimco, the world's largest bond fund manager. "We may have seen most of the weakening of the dollar that we're going to see against major currencies,"
Some analysts say the aggressive rate cuts may have put the Fed in a better position to focus solely on fighting inflation later this year.
But risks remain. Stein, the economist with Lombard Street Research, said that he expected nonfood, nonenergy inflation to remain elevated throughout 2008 and that if the Fed failed to address it by the end of the year, investors might start dumping Treasury debt, which would be negative for the dollar.
"I won't say the Fed is playing with fire," he said, "but whatever it does short term, it had better think very carefully about the longer term."
The dilemma for the European Central Bank is different but no less difficult. The euro-zone economy has shown signs of slowing, and many fear it that will get worse if the United States falls into recession.
But with inflation at 14-year highs, the European Central Bank's ability to follow the Fed's lead and slash interest rates aggressively is limited.
"Once the authorities give in to growth concerns, the euro will probably head even lower, and that will push inflation up even more," said Schultz, the executive at Allegiant Asset Management. "The biggest loser is going to be the Europeans." |
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