Opinion: Commodity price reversals upset inflation forecasts

The inflation and interest rate scene around the world is a rapidly moving feast these days. Only a few short weeks ago there were grave concerns about increased inflation caused by spiralling food and energy prices. Central bankers and the US, Europe, the UK and Australia fretted about high headline inflation numbers fuelling wage increases and “second-round” price increases, thus locking in permanent/nasty inflation. In very competitive economies like the UK and the US the risk of that occurring was certainly less than in Europe and Australia were labour market rules and agreements are more rigid and unionised. In any case, very weak economic demand makes it hard for anyone to actually achieve a price increase.

Interest rate markets in Europe and Australia have now down a complete about-flip over this last week as previous expectations of their central banks maintaining interest rates have been swamped by plummeting commodity and oil prices. Australian two and three year swap rates have plunged from 8.5% to 7.0% in just two weeks as their moneymarkets reverse-up sharply from expecting OCR increase from the RBA, to now pricing-in significant cuts. As evidenced by the 10 cent dive in the Australian dollar value against the USD over this last month from 0.9800 to 0.8800, global commodity and investment markets have suddenly realised that world demand/growth is not going to as strong as earlier forecast and Europe and Asia are now experiencing the same economic slowdown as the US. The commodity/energy price bubble is in the process of bursting in the same manner as the credit market bubble popped last year and the dot.com stocks burst their boiler in 2001. We now have the intriguing situation of everyone’s inflation forecasts for the remaining two quarters of 2008 being way too high as petrol pump prices plunge and food prices stop increasing at the rate they have been. Looking into 2009, we could see quarterly CPI figures being largely negative. This is why RBNZ Governor has now on two or three occasion reminded the doubting bank economists that he is committed to significant interest rate reductions. The economy needs them badly and they will be delivered. *Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com.