Why inflation is still a problem

Inflation is probably the last thing you're worrying about right now. After all, the coming slump will force retailers to cut prices and consumers to slash spending, won't it? Think again, says John Stepek.

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For most investors at the moment, inflation is the last thing they're worrying about.

After all, we're heading for a slump aren't we? Asset prices are falling what else matters? Consumers will feel poorer, they'll rein in their spending. Retailers will cut prices to attract custom, suppliers will have to bite the bullet and accept tiny margins nah, inflation's not the thing to worry about.

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But it's a mistake to think like that. After all, we ignored asset price inflation on the way up no one was screaming for interest rate rises to curb house price inflation (though I suspect Bank of England governor Mervyn King probably mentioned it to the Monetary Policy Committee a few times). So the fact that rate cuts are deemed vital by various vested interests when asset prices start falling, seems a little disingenuous.

Particularly when prices in everything else just keep on rising...

A quick glance at the front page of the inside section of the FT shows why inflation is something we should all still be concerned about.

The price of steel is set to rise after producers agreed to pay as much as 71% more for iron ore from the start of April. Asian and European steelmakers agreed to the hike by Vale of Brazil, the world's biggest ore supplier. Rio expects to get even more for its ore it charges a premium because of the proximity of its Australian base to the big Asian steelmakers.

Why tea is getting more expensive

Meanwhile, the latest soft commodity to take off is tea, with supplies hit by the problems in Kenya. Tea prices last year rose by 6.5% to an average of $1.95 a kilo. But prices in Kenya, which accounts for more than a quarter of global tea exports, have jumped to about $2.50 a kilo since the civil strife which has followed the disputed elections in December.

It's not just down to supply. As usual, China in particular is contributing to a rise in demand, with the Chinese drinking 13% more tea each year. And it's not just tea either. You don't have any cheap option for your morning cuppa anymore the price of high-quality Arabica coffee beans hit a 10-year high last week, and has risen by 36% in the past year. That's partly down to Kenya too because so much of Africa's trade goes through Kenya's ports, neighbouring Uganda has seen its coffee exports "virtually come to a halt," says the FT.

These price increases affect everyone. More specific to the UK, is the growing loss of confidence in our economy. Northern Rock's nationalisation might have seemed the best solution (by the way, if you want to read some sensible comment on Northern Rock, you should read Anatole Kaletsky's piece from yesterday's Times. I've been critical of his views in the past, but credit where it's due, he's been absolutely spot on about the Rock).

But the word nationalisation' carries some frightening associations. As one US blogger semi-jokingly wrote yesterday: "The UK government has just nationalized Northern Rock wait a minute, who's running things over there Hugo Chavez?" Needless to say, it's not pretty, and the news sent the pound falling even further. Simon Derrick of Bank New York Mellon told the FT "it was difficult to underestimate Northern Rock's negative impact on sterling during the past six months."

Since the news broke that the bank needed emergency funding, back in September, sterling has fallen nearly 10% against the euro. A falling pound of course means that all those commodities (priced in dollars, against which the pound is also now falling) become more expensive.

Perhaps even more importantly, inflation data just out this morning shows that prices in China are rising at an annual rate of 7.1%, an 11-year high, and looks set to grow faster. It's China's cheap goods that have kept prices down across the globe in the past decade or so. If life in China gets more expensive, life for the rest of us will too.

So don't write off inflation yet.

Shock news: lax lending means soaring loan defaults

On another note, we're often being told about academics doing research to prove the apparently blindingly obvious such as that eating too much makes you fat, or that fish don't like having hooks put through their mouths but the latest research really takes the biscuit. Gillian Tett in the FT highlights a study which wait for it suggests that the soaring defaults on mortgage loans came about because banks have become "more lax" about screening said loans.

No! Really? You mean that if you offer banks the chance to make money from selling loans to any mug willing to buy them, and pay credit ratings agencies nice fees to stamp them with AAA-approval, that you will get a decline in lending standards? Thank the Lord for science.

We shouldn't mock. For a start, this kind of research is exactly the sort of stuff that will be filling up lawsuits in the very near future as plaintiffs seek to prove that banks and agencies were careless. And the study also put a figure on it defaults on US subprime loans that were securitized have been 20% higher than those which were kept on the books of lenders "in the traditional manner."

So does that mean we can expect this housing pile-up to be 20% worse than the average one? It certainly wouldn't surprise me.

Turning to the wider markets

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Financials lead Monday's gains

In London yesterday, banks Barclays and Lloyds TSB led the FTSE 100 higher yesterday on reports that they are set to announce an unexpected increase in dividend payments to reassure investors. The blue-chip index rose 159 points to end the day at 5,946, and the broader indices were also higher. For a full market report, see: London market close.

Elsewhere in Europe, the Paris CAC-40 closed 90 points higher, at 4,861. And over in Frankfurt, the DAX-30 was up 135 points, at 6,967.

On Wall Street, the markets were closed yesterday.

In Asia, the Hang Seng had rise 363 points to 24,123, and the Japanese Nikkei was up 122 points, at 13,757.

Barclays announces 21% fall in profit

Crude oil futures had risen by nearly 1% to $96.39 this morning, while Brent spot was up $95.34 in London.

Platinum hit yet another record high - of $2,124 - today. Spot gold had risen to $907.50 this morning, and silver was also higher, at $17.13.

Turning to forex, the pound had fallen to a one-month low of 1.3240 against the euro and was trading at 1.9495 against the dollar. And the dollar was at 0.6789 against the euro and 107.62 against the Japanese yen.

And in Europe this morning, Credit Suisse tumbled by as much as 8% this morning after announcing an unexpected $2.85bn write-down resulting from an investigation into the mispricing of assets. Meanwhile, fellow bacnk Barclays announced a 21% fall in H2 profit, with Barclays Capital posting $1.6bn in writedowns. Barclays shares had fallen 4.5% in London this morning.

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John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.