Tuesday, 29 July 2008

Katainen: Inflation Back to Target within 12 Months?

"The Ministry of Finance expects the growth in consumer prices to show a clear slowdown next year. Projections released on Tuesday envisage a rate of inflation in 2009 of around 2.8%."

"We have probably seen the peak of the inflationary spike in food and oil prices, and it will ease during the year, Of course, no one knows for certain, but it could be that by the end of 2009 the rise in prices will have come so far down that we'll be close to two percent."
said Finance Minister Katainen.

Have you ever though how inflation is calculated? it's a year on year increase so if the petrol price is hovering at around 120 dollar/baril by next year at the same period, then oil price will not affect inflation figures directly as no increase has occured.

The same scenario apply to food.

So if the producers/market participants don't pass past increase to the consumer, then inflation will fall sharply.

It will fall irrevoquably since the housing market would have already been on its own downturn, pushing some prices lower (any buiding materials, cement etc...).

Another point to make regarding a falling inflation, is about interest rates. If inflation is falling and second round effects are not happenning while The Euro Economy is slowing sharply then indeed Interest rates will start falling pushing debt servicing lower thu affecting some part of the inflation figures.

Now this scenario (sharp fall in inflation) contains some risks, and is link to a sharp fall of the Euro (it's fine as long as commodities are falling too), U.S. slowing less than planned and emerging market recovering from the slowdown there are witnessing: commodities could then rally and oil could reach 200 dollars/baril as some have put forward. Lots of if, so a falling inflation looks more likely.

I'm convinced that inflation will fall, no doubt about it as banks are going to tighten credit standard, less money available will push some key asset lower (housing, cars, electronic, house appliance, construction material...and land prices). The U.S., U.K. and many other countries will tighten their belt for a few years to come that will slow down the global economy pushing a very modest growth for European countries at best. Slow growth would mean lower inflation...

Obviously if growth is stronger and more resilient than planned, and if the 4th oil shock happen (oil over 200$/baril), then the income tax cut and vat cut would be an historical mistake from katainen, that would be remembered as the one who pushed finland in its second biggest depression of the 21th century...

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