Friday, 18 July 2008

Inflation Back to Target within 18 Months

That is to say, inflation will be around or close to 2%...

"We are there to tell households as well as enterprises, all social partners, that we will maintain price stability less than 2 percent, close to 2 percent — in the medium term," Trichet, the European Central Bank president, said in the interview.

"Today, price setters and social partners must take into account that we will be back to price stability — in line with our definition — say over 18 months," he added.

So for the one who thought that inflation will "eat your debt", they got it wrong, as inflation will vanish gradually.

Companies or individuals that build up debt thinking that a 70's scenario was on the card, are condemned to pay debt all the rest of their life, restricting any further moves or investment.

For companies that have sharply increase their price (e.g M-Real, by 10%), in order to pass their high cost to consumers or client, will be uncompetitive and most probably will go bust sooner rather then later.

Food inflation is clearly a temporary as already highlighted in this blog, as price soar, more production is put forward attracted by high profit. An oversupply is then created, plummeting those prices (this can already be witnessed with Rice , Eggs etc...). Now if price don't fall in Finland, then you could clearly suspect, price fixing, cartels or some kind of fuzzy indexation - a socialist type of price regulation ...

Oil has been overextended, and has shown all the characteristics of a bubble. It went up to high and too fast, the reverse will happen the same way. Although i agree on the long term price could be higher than there are today...but the same was said in the 70's...they were right, indeed after three decades...

I think the threat that could be on the card is more a deflation threat on the medium term as Housing deflate and banks deleverage at a time of a severe global correction. Households already fully loaded with debt will buy the strict minimum or the cheapest products around pushing prices even the end cash looks like king and its purchasing value will increase as time goes.

Inflation is a short term threats, most probably in the headlines up to 2009 then will vanish for at least a decade as banks lend less to rebuild their balance sheets... or do you have any other opinion?


Andrew said...

I think the debate over inflation versus deflation is alive and well.

If we had free markets and banks could only rebuild their balance sheets via their own efforts then what has happened and is about to happen would be very deflationary.

Meanwhile we have high inflation that 'surprises' to the upside.

As for impossible 70's scenarios according to Danske? Bank finland already has a spike in wage increases? Not surprising when inflation here is rediculously high.

When Central bankers tell us inflation is low or under control or is getting lower and everything is going up in price then we get 70's type scenarios as ordinary people fight to survive the relentless devaluation of their money.

Even thru the "low inflation period" Finlands prices have gone sky high. Convert anything to old marks and people gasp at what they are now paying. Thats the reality.

Then there are events outside of Euroland which the ECB also has to take into account. The ECB cannot be an island of prudence in an inflationary world - as the past has already proven - even if it earnestly wants to be.

HousingFinland said...

I think it's clear that at the end of the business cycle price shoot up as in good time people behave as it will last forever...

House price is a clear example, it went up in the past decade and people, even the smarter one, cannot think that price will go down...the psychology plays a bigger role than the fundamentals...say that to the Irish, english or the american citizen, they would not have believe for a second that the house their purchase was in the 20%-40% overvalued...

This is no much difference than in any latest business cycle, in the late 80's we had as well a credit crisis, people debt sky rocketted and inflation was a threat...all was followed by a deflationnary period: asset price plummeted, salary were readjusted downward as people were seeking to have a job for whatever pay.

Finland will position itself quite badly in the world stage if wage were to spiral out of control...

Look at Finnair...pilot are asking more a time of high oil price. Should Finair pass the increase on air ticket, then either people won't travel any further, travel locally or look for an alternative company such as ryanair or blue1 etc... so it's a lose-lose game for any of the party involve... at the end Finnair will restructure itself and shed lots of jobs in order to survive.

So it's not like in the 70's where company as such could increase price counting on massive salary increase..time has changed as we live in a global world and policy maker understand better monetary phenomenon...

I clearly remember in 2000, a survey asked common people what was their opinion on share prices increase in the next few years: they were seeing a double digit growth in the range of we know thereafter price plummetted by 10%-80% in the 3years that followed.

Should the same type of survey be conduted for the housing price, I will not be surprised to see people putting more increase or for the most pessimistic a stabilization...

Andrew said...

lets not mix apples with oranges.

House prices will/might fall but are we going to see inflation back to the target in 18 months?

Central bankers like to keep money and inflation as something mysterious and would have us believe that money and inflation are better understood then it was decades ago.

Meanwhile todays crisis is more or less a rerun of the 1920's. It is not that money and inflation are now better understood it is just that bankers will be bankers.

But there is one difference today and that is the ability to inflate the economy with no regard to the cost of money. There is no cost to money today for central bankers and unlike in the 1970's when supposedly so much gold was shipped from Fort Knox to the BOE, that the weighing room collapsed, no such movements are likely.

And so we have a crisis which by traditional situations would mean severe recession but today means stagflation at worst - prices are not going to go down all that will happen is money will be adjusted around the existing debt. Mr Paulson plays the perfect negotiator for the world to cut America some slack and allow it to devalue its money. He seems genuinely terrified and desparate:-)

Wages in Finland might be spiralling up but in reality all that is happening is wages are rising to meet the same cost of everything that the wages met before.

Everything is going up because central bankers are focusing their action on easy money and their words on the results of their easy money policy.

However bit by bit policy will have to be tightened. Bit by bit local banks will be forced to raise rates. Bit by bit life will become genuinely more expensive for most people.

But will inflation come back to the target in 18 months? I just find that more or less impossible to believe. How about a 20 Euro bet? Or lets say the cost of a few beers and a meal at the expense of the loser? :-)

HousingFinland said...

The Euro area has a different approach than the one folowed by the AngloSaxon. The latest group prefer to foster growth while putting inflation in the second plan. The ECB approach is different as their main focus is inflation, a low inflation that de facto will set the seed for continuing growth.

Should inflation expectation or secound effect (wage spiraling) materialize, then the ECB will act and will do it strongly. You can translate that by the ECB raising rates higher, sharply higher (5% could be on the card next year and higher if such conditions appear- The Euribor could shoot temporarily to 6%-7%).

Now you have to look back to the history, in particular to the German Bundesbank...

In 1992, the Chief bank said :
"We don't see interest rates the way many people in the United States or in Britain do, as a way of influencing unemployment or stimulating business activity," one bank official explained. "We see them as a tool we use to do what our statute requires us to do: to keep the money sound and the rate of inflation low."

That clear is the fundation of the ECB, the old Bundesbank moto.

That's the reason, I believe that within 18 month, inflation will be lower than today.

Have a look at Trichet interview :

Again I repeat that mistakes made in the 70's to let real interest rates negative, thus drowning savers and transfering the wealth to the debt holder WON'T HAPPEN. This time bank are independent, and corruption and bribes don't exist...luckily the Finnish parliament doesn't set interest rates as they will have certainly followed the same strategy as in the 70's helping the big business and the "wealthy" or the ones who got loans by the banks at the not the poor or the average citizen...

Regarding the bet, I suppose that in 18 month - 2010 - the housing market would have already started it downward path and some economy in Europe would have already be in technical recession , this would inevitably push interest rates lower amid a falling inflation. I guess in that sense it's safe bet ;->,

Andrew said...

I will assume you dont have a direct line of communication to the hearts and minds of policy makers at the ECB and can only form your opinion in the same way i can. Ie we observe what they do and then draw conclusions.

Inflation is too high, money is being devalued and rates should be higher. And even worse for many years they have been too low to 'stimulate the economy' by running an 'accommodative' monetary policy.

But lets assume the ECB are the Saints of money. What they dont control is the ability of governments to lower taxes or provide stimulus to their economies. It seems Finland has decided to perhaps pay for its elite opera house by taxing ordinary families on child care? So we can say that Finland is running a prudent fiscal policy even if it is 'unfair'.

But if the ECB thinks it is convenient to have higher rates it will do so. At the moment dispite the rentless devaluation of money the ECB has decided it is not in the interests of the economies and owners that matter to have higher rates. We can guess though that as soon as Germany/france heads towards recession there will be lower rates, if by then, inflation is not exploding off the scale. At the moment inflation is in the early stages of exploding off the scale.

And so even as right now recessionary forces are building all the while a stimulative monetary policy is being run with banks having an unusual access to the ECB for lending and while the ECB is providing access to below market money. Unless the ECB wants to end up feeding the lending requirements of half the planet it needs to raise rates but so far it is saying it is in a neutral stance. Somewhat rediculous considering its current stimulative bias surely?

So we can conclude there is no current sound money policy. Money is being devalued. Rates are too low. Monetary policy is being used to stimulate the economy.

It might be worse elsewhere but we dont live elsewhere we live here where prices are more or less exploding.

Rates will go to 5% when the effects of the stimulative monetary policy force them to go to 5% but meanwhile the stimulative monetary policy will have inflation needing yet higher rates.

18 months minus one week and counting!