Sunday, February 13, 2011

The inflation debate continues to intensify

Equity markets in many developing regions have performed poorly as their inflation rates approach and extend beyond 4% (see chart). This past week, China's central bank, in its continuing fight against inflation, raised interest rates for the third time since mid-October. Inflation is challenging several other economies including Brazil, India, Indonesia and South Korea; and the UK is approaching the critical 4% tipping point. Senior managers at firms such as Kraft Foods, Inc (US: KFT), Kellogg Co. (US: K) and PepsiCo, Inc. (US: PEP) have suggested that increased commodity price inflation may negatively affect their business. Additionally, the Reuters/University of Michigan US consumer sentiment survey, noted that inflation expectations, which were 2.2% in September have increased to 3.4%. Providing an alternative perspective, Federal Reserve chairman Ben Bernanke told the House Budget Committee this week that “inflation is expected to persist below the levels that Federal Reserve policymakers have judged to be consistent over the longer term with our statutory mandate to foster maximum employment and price stability.”

MY TAKE: In an increasingly interconnected global economy, trends such as inflation are likely to be shared in one way or another by most market participants. While the Federal Reserve and some economists may discuss inflation in terms that often excludes the impact of food and energy costs, if people feel like there is inflation, they will likely behave as if there is inflation. As many events in the past few years have demonstrated – perception is a significant factor in shaping reality.

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