A warning sign for inflation

by Ed Bowsher on 03 September 2009  |  5 comments
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I'm becoming slightly less sanguine about the threat of inflation.

As soon as central banks started to aggressively cut interest rates at the end of last year, some commentators were worrying about the threat of renewed inflation. Those worries were strengthened when the Bank of England started to 'print money' via its Quantitative Easing (QE) programme.

The inflation hawks reckon that if the supply of money increases rapidly in an economy, then inflation will inevitably start to rise quickly too. So, according to this view, if we're not careful, price rises could get out of hand and we would face a new inflation-driven economic crisis.

Now although I've never completely ruled out the above scenario,  I have been relatively sanguine about the inflation threat over the last year. The level of demand in the economy was seriously damaged by last autumn's crisis and given that background, deflation seemed a greater threat to me than inflation. I've not expected inflation to be a problem until 2011 or later. If at all.

What's changed?

I read a very interesting article yesterday on the breakingviews website (sadly, subscription only) which highlighted an early warning sign of looming inflation. The piece looked at the August US ISM manufacturing report which records purchasing managers' views of business conditions.

65% of respondents said that prices were rising, compared to 55% of managers a month earlier. Yet only 46% of managers said that employment was rising. So if that trend continues, we might face a 70s-style scenario where prices rise fast whilst unemployment stays high.

It's also interesting to note that gold has been on the up this week. The gold price has risen 3% to $987. Gold is often seen as a good investment to hold in inflationary times so that suggests that some participants think inflation is round the corner.

Now it's early days, and I'm still not convinced that inflation is set to soar in the very near future. But I want to keep an open mind and I'll try to evaluate all new data with a fresh, unjaundiced eye.