Panic Over?

It looks like the great panic is over, for now. The markets were in the green today after heavy losses last week, including a disastrous trading session on Friday. Being the Stock Market we can't say for certain whether this is the bottom, although I would imagine we are fairly close to it. What it has revealed, and will reveal further if there are any more heavy losses, however, is the knife-edge that the whole debt-based financial system lives on.

To a short-term bull and long-term bear like myself, it doesn’t really look like things have actually changed that much. Corporate profits are still good and they should be the main marker for the performance of stocks and shares. Moreover, that elusive recession seems to be somewhere on the horizon but is certainly not close enough to really worry about. So in all reality this is solely about debt, and central banks who give platitudes about Adam Smith and liberal markets but to whom John Maynard Keynes is still the role model. That is why I am calm about the near future; central banks will simply not allow the debt-based economy to collapse. At the first sight of any signs that the economy may be in difficulty, liquidity will be flooded in and interest rates slashed.

What about inflation, I hear people say, haven't the central banks said they are going to fight it? Well, yes, the central banks have talked about inflationary concerns over the last couple of years, and interest rates have been raised accordingly. But, in all reality, faced between the choice of the whole debt edifice collapsing around their heads and inflation being set loose, I think they will choose the easy option. Ergo, inflation will be set loose, and we all know what I believe is the remedy for this.

That Escaped Rabbit

So, the result of mild weather has directly led to oil prices falling to a two-year low, stuck in the $50-55 barrel range. Natural Gas has suffered, too, with lower use of central heating.

But what goes around comes around. What the weather has given with one hand it has taken away with the other. Because of scorching drought in Australia, the grain harvest was severely affected. That has sent the grain price soaring, which will feed through into higher prices for all staple produces.

That is from post on this blog, in January of this year.

Let me turn to the reasons for the rise in CPI inflation to 3.1 % from 1.8% a year ago. As discussed in our February inflation report, part of that rise reflects an unexpectedly sharp increase in domestic energy prices during the second half of last year, more than offsetting a fall in petrol prices. Part reflects a rise in food prices cause by a weather-induced global reduction in supply.

That was Mervyn King's letter to Gordon Brown, explaining the reasons for the CPI surpassing 3% despite the recent interest rate rises. Glad to see he's caught up.

So, whilst we are on the subject, where will inflation go next? Well, I am not as easily convinced as many analysts that the bank are on top of the problem, and that we will see a reduction coming through very soon. The high energy prices from last year will fall out of the system, which will undoubtedly have some sort of an effect in reducing it. That's hoping, of course, that oil prices stay at their current level all summer. To achieve that we need to buck the trend for oil increasing during the summer months, and we would need to avoid anything which could lead to oil prices hitting $70+. So, no wars, Hurricanes, supply problems or sweltering heatwaves. Do you feel lucky, Mervyn?

Then there is dear old Gordon's taxes. Even if the oil price doesn't reach $77 dollars a barrel, and even with the fact that oil is cheaper for us now that the Pound is so 'strong' (actually it's the Dollar that is so weak), there is a very strong chance petrol will hit £1.00-a-litre.

I can see, therefore, inflation hanging around the upper 2% range, for the near future. Coupled with the UK's rising trade deficit and with unemployment rising again, the economic future is not looking particularly bright.

The Inflationary Rabbit's Escaped

Who’d have thought that inflation would be such a big topic in general conversation? Certainly not me, that’s why I relied on my blog to vent my opinions on why we were headed for higher inflation, last year. And, as inflation is a lagging indicator, it’s the effects of last summer we are feeling now. So, if the BofE had raised rates in May, more than likely the ‘shock’ that that would have produced, would have led to no renewed housing inflation, and a slow down in the high street instead of people continuing to overspend, so inflation would now be under control.

Even the media have come to this conclusion, now. For instance, the Sun’s Fergus Shanahan states in his column today:

The Bank has been sloppy too, waiting too long to act and letting inflation get a dangerous hold again which will be difficult to break.

What effect the rate rise will have is difficult to fathom. It's obvious that previous rate rises have not stopped inflation. However, from what they have said, the government and the Bank are convinced that inflationary pressure will reduce by the end of the year. Presumably, that will be due to the lowering of energy prices in the last five months, feeding down to lower prices in the high street.

They may have a point with regards to energy prices, as we have had a winter without a hint of frost and snow here in North Cheshire. It’s scheduled to change soon, but I am not exaggerating when I say that I can never remember a winter this mild. And, the same is true not just of the North of England, but the whole of England, the British Isles, Europe and the other side of the Atlantic. So, the result of mild weather has directly led to oil prices falling to a two-year low, stuck in the $50-55 barrel range. Natural Gas has suffered, too, with lower use of central heating.

But what goes around comes around. What the weather has given with one hand it has taken away with the other. Because of scorching drought in Australia, the grain harvest was severly affected. That has sent the grain price soaring, which will feed through into higher prices for all staple produces.

The effect of the wheat prices will not, however, be as inflationary as high oil prices, so all in all that could help to reduce inflationary pressure. So, with oil prices unlikely to go anywhere near $80's a barrel this year, perhaps the government are right not to worry too much. But, it could be only a temporary respite when you consider the China factor. And, finally, with retail prices still climbing, it suggests that inflationary pressure is still in the process of building up. Only when that falls will inflation likely to come down, and even then it will take a while to filter down.

All in all, I find it very difficult to see a situation where the Bank will be able to lower interest rates this year. So, any sign of a spiral towards stagnation or recession cannot be counteracted by an interest rate cut, without inflation being set free to wreak havoc.