A weakening US dollar and rising commodity prices led by gold are once again heralding the risk of rising inflation even as the global economy begins to recover.
Having taken a break for most of this year because of the recession’s dampening impact on demand, inflation is expected to be one of the major challenges for policymakers across the globe in 2010.
They cite three main reasons: a weakening US dollar as it loses its safe-haven status amid the global economic recovery; the timing and ability of policymakers in key industrialised countries to pull back the huge amount of liquidity injected into the world’s financial markets by the loose monetary policy implemented during the recession to boost growth; and rising commodity prices, spurred by a weaker greenback and rising demand.
A weakening US dollar makes commodities attractive because most of them are traded in the US currency. Investors are taking flight to precious metals, especially gold, to preserve the value of their US dollar assets and also to hedge against inflation.
The price of spot gold on the New York Mercantile Exchange’s Comex hit a record high of US$1,050 last Thursday while December crude palm oil (CPO) futures rose to RM2,150 a tonne from RM2,100 the previous day.
Gold bullion prices have risen by almost 20% since the beginning of the year. Metal analysts, according to news reports, have opined that prices will continue to rise gradually to touch US$1,100 by 2010.
At Thursday’s close, crude oil for November delivery was traded at US$71.69 a barrel in New York, up US$2.12 from the day before. In London, Brent crude oil was traded at US$69.77, up US$2.57 from Wednesday.
The general view is that the US dollar will likely face downward pressure in the months ahead as global recovery picks up pace. Additionally, the US currency is being driven down by its huge twin deficits as well as talk of attempts by some Arab countries — together with China, Japan and France — to end US dollar trade in crude oil.
According to an article in UK newspaper The Independent, the plan is to move trade in oil from the US dollar to a basket of currencies comprising a unified currency for the Gulf economies, the yen, the euro and the yuan.
As an aside, this shift is unlikely to happen in the short term, given that several of the Gulf states have long been talking about a unified currency but with little to show for it.
In the last three months, the US dollar has lost some 16% against the euro and more than 10% against the yen. On the home front, the ringgit has been a laggard, gaining only 2.23% to trade around RM3.38/40 currently against the US dollar since the middle of this year.
A continued weakness in the US dollar will boost commodities. Rising commodity prices, including that of crude oil, will fuel inflationary pressures and may pose a threat at a time when the world economy is just beginning to recover from one of its worst recessions ever.
This is because rising inflation in an environment of low growth will pose a dilemma for monetary policy. Policymakers will have to perform a delicate balancing act between raising rates to dampen inflationary pressures and boosting growth.
It must be noted that while the global economy is recovering better than expected, industrialised countries are still facing high unemployment rates, thus hindering a pick-up in consumption spending.
The consensus among economists is interest rates have bottomed out and will likely start rising again as we move into 2010. Australia, one of the few economies that have escaped a recession, surprised the markets last week when the Reserve Bank of Australia (RBA) raised its cash rate (policy rate) by 25 basis points to 3.25% to keep inflation down and growth sustainable. The Australian economy grew 0.3% in the first quarter and 0.6% in the second.
What this signals is that liquidity in the financial systems will gradually be tightened, going forward, and that there is a turnaround from deflationary to inflationary fears among investors.
Last week, though, other central banks did not follow RBA’s move during their monthly policy meetings. Both the Bank of England and the European Central Bank kept policy rates unchanged at 0.5% and 1% respectively. South Korea also kept its rate unchanged at 2%.
Most Asian central banks are not likely to raise rates significantly even in 2010 because of concerns that higher rates will cause their currencies to appreciate, which will in turn erode the competitiveness of their exports at a time when exports are still a key growth driver.
Bank Negara Malaysia is expected to keep its overnight policy rate unchanged at 2% for the rest of the year. Inflation is still benign, coming in so far this year at 1.2% y-o-y and projected at around 1% for 2009 as a whole. For 2010, inflation is forecast at 1.5% to 2%, which is on the low side.
Boosting growth will still be a priority, which means that any rate hikes by Bank Negara will likely be small.
This article appeared in Corporate page of The Edge Malaysia, Issue 776, Oct 12-18, 2009