Home Bubbling inflation risks could create new dilemmas for central

Bubbling inflation risks could create new dilemmas for central

Inflation risks in the world economy could be ratcheting up, despite the winding down of the US Federal Reserve’s quantitative easing programme posing a new dilemma for central banks, which could have a considerable impact on forex markets.

A resurgence of inflation would hit GBP and USD, but would likely be positive for emerging market currencies closely tied to commodity prices.

Quantitative easing was designed to re-inflate economies and stimulate demand. So far the inflation impact has been muted, at least in the real economy. But there is a danger this could change.

A classic path towards inflation involves the creation of lots of new money and the first signs of inflation usually turn up in soaring stock markets, which has already happened.   As confidence increases the next phases show up in the real economy.

By Justin Pugsley, Markets Analyst MahiFX. Follow  @MahiFX  on twitter

Property markets are always a favourite as banks feel comfortable lending against this kind of asset. From there the money starts to trickle into other areas of the real economy. In the UK the property market is already very buoyant though that’s not quite the case in the US. But that could change.

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Gold and inflation Summer 2014 technical chart for advanced analysis

The inflation cycle

Once inflation becomes well established it is widely reflected in fast rising prices of retail goods and wages.

Retail prices would rise given the commodities from which consumer items are made could soar in value. Indeed, a correction in the stock market could see investors shift their money to property and commodities reigniting not only fears over inflation, but also a re-occurrence of property bubbles followed by crashes.

A particular issue for the UK and to a lesser extent the US is the amount of indebtedness of consumers and the state. The Bank of England admitted there could be limits to the scope of increasing interest rates due to high personal debts.

That would suggest that relatively high rates of inflation could be tolerated for fear of bankrupting too many borrowers. If that happened then GBP and USD would see their values steadily eroded away on forex markets. The best policy for the UK and US central banks could be to raise interest rates sooner rather than later, which should negate the need to raise them to particularly high levels.

On the other hand there are a number of significant inflation dampeners:

Banks are still scarred by the financial crisis and are having to hold higher reserves. Policy makers, even in the UK, are much more focussed on property bubbles and are more prepared to use macro-prudential tools to stop them getting out of hand.

Wages in most of the developed world are under pressure due to the effects of globalisation, digitisation and the fact that companies are keen to trim workforces even when profits are rising.

Another issue are ageing populations, which could also dampen consumption and are likely to shift it more towards services and away from goods.

It’s still difficult to tell if inflation will take off again, but central banks have created an enormous amount of new liquidity since the financial crisis. If economies really are normalising again all that extra money could come into play with a vengeance and create a whole new set of dilemmas for policy makers.

Further reading:  Do central bankers know what they’re doing?

Justin Pugsley

Justin Pugsley

MahiFX is headed by David Cooney, former global co-head of currency options and e-FX trading at Barclays Capital and responsible for the award winning e-commerce platform BARX and Susan Cooney, former head of e-FX Institutional Sales in Europe for Barclays Capital. Operating as a market maker, MahiFX provides traders direct access to institutional level execution speeds and spreads through its proprietary-built fully automated pricing and risk management technology, lowering the cost of retail forex trading. MahiFX global operations are headquartered in Christchurch, New Zealand with offices in London, UK with development and support teams in both locations for 24 hour service. The company is regulated by The Australian Securities and Investments Commission (ASIC), Australia’s corporate, markets and financial services regulator. Article by Justin Pugsley, Markets Analyst MahiFX  Follow MahiFX on twitter and on facebook  Disclaimer: This material is considered a public relations communication for general information purposes and does not contain, and should not be construed as containing, investment advice or an investment recommendation, or an offer of or solicitation for any transactions in financial instruments. MahiFX makes no representation and assumes no liability as to the accuracy or completeness of the information provided. The use of MahiFX’s services must be based on your own research and advice, and no reliance should be placed on any information provided or comment made by any director, officer or employee of MahiFX. Any opinions expressed may be personal to the author, and may not reflect the opinions of MahiFX, and are subject to change without notice