Inflation Concerns

When the printing presses were turned on by central banks in 2009 and 2010 there were many who held the view that the only logical outcome would be a significant rise in inflation.  With global growth still recovering from severe trauma post Lehman Bros, there was concern that we would enter a period of slow growth and high inflation.  The job of central bankers around the world was to finely balance attempts to kick start economic growth without allowing inflation to get out of control.

The concern with inflation is whether it is “good inflation” or “bad inflation”.  Good inflation refers to an expanding economy where wages are growing and output is expanding.  Increases in the prices of goods and services are a direct result of a strong and growing economy.  Bad inflation refers to increases in the prices of goods and services caused by external factors when the economy is slowing or contracting.

While growth has returned to parts of the global economy it still remains lower than trend and is being supported by government monetary and fiscal stimulus and not domestic demand growth.  Inflation on the other hand has begun to increase significantly.  What has been important to note is that the main driver of this inflation increase has been rising commodity prices.  Oil is approaching $100 a barrel and agricultural commodities are posting new multi-year highs such as bad weather, political instability and continued growing demand from the developed world.  Currently commodity prices are adding in the region of 1% to annual inflation readings.  With unemployment reaching double digits in most economies and wages falling this is “bad inflation”.

Our view remains unchanged in that we believe that inflation from growth is unlikely to push higher given spare capacity in all areas of economies and a strategic shift in investors towards savings and balance sheet repair which is likely to be a multi-year process.  The significant increase in commodity prices however, has forced us to re-consider that there could be a continuing rise in “bad” inflation in the short term.  Our preferred strategy for hedging against current inflation concerns is to use the commodity complex to add positions to your portfolio. 

The Irish Economy

Sticking with inflation concerns, in last quarter’s Quintas Newsletter, we highlighted the subtle trends in Irish inflation whereby increases in fuel and electricity prices were increasing being offset by falling prices of food and clothing.  We highlighted the risk to our view of low Irish inflation coming from increased global commodity prices – which as we explain above is beginning to threaten global inflation trends.    As a small open economy prices for our goods and services will be influenced by changes in prices in the broader global economy and with pressure from food and energy prices continuing the future trend of price changes will be inflowing by the interplay of domestic deflation and global food and energy inflation.

Unemployment remains stubbornly high despite record emigration numbers.  Forecasts are for slight increases in unemployment numbers in 2011 before they begin to fall in 2012 as growth takes hold while emigration numbers are expected to continue to be steady.  Our fiscal balance is expected to improve significantly in 2011 as the bank bailout has been taken as a single hit in the fiscal balance for 2010 though further losses cannot be ruled out, as was evidenced by comments by Central Bank Governor Patrick Hounihan earlier this week.

Overall the Irish economy remains in a state of flux.  Our export sector continues to enjoy a solid rebound in activity and is very much a bright spot of economic activity.  Unemployment however, remains the single most pressing concern and should be the core focus of the new government.  Global factors are likely to help in the medium term as growth takes hold though global inflation trends could be a potential risk. 

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