Strategic Briefing | 3.1.2011 | Commodity Inflation

Prospects for the Economy and Monetary Policy
William Dudley, president and CEO, NY Fed | Feb 28
…we need to keep a close watch on how households and businesses respond to commodity price pressures. The key issue here is whether the rise in commodity prices will unduly push up inflation expectations. Although there have been commodity price cycles in the past, commodity prices have not consistently increased relative to other prices, and indeed have declined in relative terms over the very long term. Historically, if commodity prices rose sharply in a given year, it has been reasonable to expect that these prices would stabilize or fall within a year or two. This property has been important because it has meant that measures of current “core” inflation, rather than current headline inflation, have been more reliable in predicting future headline inflation rates.
In contrast, over the past decade, commodity prices generally have been on an upward trend….
Nevertheless, there are important mitigating factors that suggest that it would be unwise for the Federal Reserve to over-react to recent commodity price pressures. First, despite the general uptrend, some of the recent commodity price pressures are likely to be temporary. In particular, much of the most recent rise in food prices is due to a sharp drop in production caused by poor weather rather than a surge in consumption. More typical weather and higher prices should generate a rise in production that should push prices somewhat lower. This is certainly what is anticipated by market participants. Second, even if commodity price pressures were to prove persistent, the U.S. situation differs markedly from that of many other countries. Relative to most other major economies, the U.S. inflation rate is lower and the amount of slack much greater.
Moreover, for the United States, commodities represent a relatively small share of the consumption basket. This small share helps to explain why the pass-through of commodity prices into core measures of inflation has been very low in the United States for several decades.

EU Raises Growth Forecast, Expects Inflation to Accelerate
Bloomberg | Mar 1
The European Commission raised its economic-growth forecast for 2011 and said higher oil and commodity prices could keep inflation above the European Central Bank’s limit for most of the year.
Commodities in Longest Winning Streak Since ’04, Beating Stocks
Bloomberg | Feb 28
Metals, crops and fuel beat stocks, bonds and the dollar for a third straight month, the longest stretch since June 2008, as inflation lifted cotton and cocoa and investors speculated violence in the Middle East and northern Africa will restrain energy supplies. The S&P GSCI Total Return Index of 24 commodities gained 3.8 percent in February and rose for a sixth consecutive month, the longest streak since 2004, data compiled by Bloomberg show. The MSCI All-Country World Index of equities in 45 nations returned 3 percent including dividends, while corporate and government bonds rose 0.13 percent, according to Bank of America Merrill Lynch’s Global Broad Market Index through Feb. 25. The U.S. Dollar Index, a gauge of the currency against six counterparts such as the euro and yen, fell 1.1 percent.
Commodity Shock
Tim Duy’s Fed Watch | Feb 27
The recent surge in oil has been a blow to my rising optimism. With this surge coming on the heels of accelerating US activity, monetary policymakers will offer some concern over the inflationary impact. Recent history, however, suggests the opposite – that unless the tide of rising commodity prices is soon arrested, Fed officials will find themselves faced with the prospect of yet another round of quantitative easing.
Macro US: Commodity bubble? Well, US inflation is at an all-time low!
Trading Floor (Saxo Bank) | Feb 28
While personal spending and income may seem like the two biggies in today’s spending report, we encourage you to study the price data – particularly in light of the recent rise in inflation as measured by the consumer price index. Of today’s price series the PCE Core Price Index is of particular interest given the attention it gets from members of the Federal Reserve. Unlike the CPI, the core PCE price index does not yet show many signs of inflation. Indeed, the year-on-year rate is 0.7 – the lowest rate ever in its five decade history. To be fair the three month annualised measure has increased… but only to 0.4 percent from an all-time low of 0.3 percent. Keep this index in mind when worrying about U.S. inflation and Fed actions.
Reserve Bank of Australia member warns of commodity bubble
Australian Broadcasting Corp | Feb 28
Reserve Bank board member Professor Warwick McKibbin has warned of a potentially devastating bubble in global commodity prices and property prices in Asia. Professor McKibbin, who is also director of the research school of economics at the Australian National University, says if there is a big downturn in Asia Australia could be hit harder because of Australia’s reliance on resource revenue…
“There are two things driving commodity prices. There is the fundamental shift in the demand for commodities coming out of China and India and other countries. That is a positive,” he noted.
“The second component is the excess demand which is leading commodity prices, but generalised inflation will follow and that is not a good thing because that is a temporary phenomena for a country like Canada or New Zealand.”
Nikkei gains helped by Japan’s low inflation risk
Reuters | Mar 1
Japan’s Nikkei average clawed back towards 10-month highs to add 1.2 percent on Tuesday as foreign investors piled into Japanese stocks on a lower inflation risk, with more hard-won gains seen in the medium term… “U.S. and European investors have been the main players in the Japanese market. But Asian investors have joined in as Japan is one of the few countries with a low risk of rate hikes,” said Shun Maruyama, chief strategist at Credit Suisse. “They are buying Japanese stocks on a process of elimination as Japan has more tolerance for higher oil prices than other Asian countries.”
High global crude, commodity rates may add to inflation: Pranab
The Hindu | Mar 1
Grappling with a high rate of price rice, the government today expressed concern that increasing prices of crude and other commodities in global markets could add to inflationary pressure in the country [India]. “The possibility of the global commodity inflation adding to domestic inflationary pressures cannot be ruled out,” Finance Minister Pranab Mukherjee said at the 83rd Annual General Meeting of industry chamber Ficci here.
Why is the GOP Overhyping Inflation Fears?
David Frum | Feb 28
It’s no mystery why Republicans should be more acutely sensitive to inflation than Democrats.
1) Republicans are the preferred party of people who have money. People who have money naturally dread anything that might impair money’s value.
2) Republicans are the party of older people. Older people naturally dread inflation, which corrodes fixed incomes and retirement savings.
Monetary Policy, Commodity Prices and Inflation – Empirical Evidence from the US
Florian Verheyen, University of Duisburg-Essen | Nov 19, 2010
While there was a strong link between commodity prices and CPI inflation in the 1970s and the beginning of the 1980s, the relationship has weakened, respectively diminished over time. Today we are unable to detect a reaction of commodity prices to commodity price shocks. Thus, commodity prices might not serve as good indicator variables for monetary policy…
Furthermore, a more restrictive monetary policy in face of rising commodity prices could depress economic activity. This is problematic especially for the Fed as she has to focus on price stability and the support of the economic performance of the American economy. Regarding the actual financial crisis, putting more weight on stimulating the economic activity might be superior to eliminate inflationary pressure. Additionally, higher inflation rates as a consequence of the fairly expansionary monetary policy would come along with a (to some minds) nice side effect of devaluating the governmental debt. Therefore, keeping interest rates low might lead to a reduction of the deficit relative to GDP for two reasons: higher growth rates decrease debt relative to GDP and inflation erodes the real value of the debt.
Nevertheless, central banks should monitor if commodity prices will influence inflation expectations. As food and petrol are goods which are bought quite frequently, a rise in these commodity prices can increase inflation expectations, with the risk of a stronger influence of commodity prices on the CPI in the future. So the hypothesis of a revival is not so far off which points to no quietening of the discussion about commodity prices, monetary policy and inflation.