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Food fuelling inflation

Food prices are a notable source of inflationary pressure and have been a problem in many emerging markets, India and China being good examples. This reflects local and global supply disruptions alongside rising demand pressures. Soft commodity prices have moved up very sharply in recent months.

This is particularly problematic because food is a significant component of CPI baskets in many emerging economies, where, in some cases, food is more than 40 per cent of the basket compared with less than 15 per cent within the US and the eurozone. Shocks on the supply side have a much bigger consequence on headline inflation in emerging economies.

Another contributory factor is the unsterilised currency intervention via the second wave of quantitative easing. In response, many emerging market central banks are intervening in currency markets, buying US dollars in an effort to cap and mitigate appreciation pressures. External liquidity is turned into domestic liquidity and not all this intervention is sterilised via open market operations. If inflation ends up being the result, there would be real appreciation through the back door, via an adverse inflation differential with the developed world and currency intervention would ultimately prove to be self-defeating.

Additionally, markets such as India and China did not suffer a decline in output during the “global” recession, where there was only a slight moderation in growth. With the reacceleration of activity, output gaps in emerging markets have narrowed and turned positive in a number of instances, so pricing power has returned to many labour and product markets.

The labour market could be an important transmission channel for inflation pressures in some of these economies. If real wages grow at a faster pace than productivity and the result is passed through to product markets, inflation pressures are likely to increase. Brazil remains a good example – the labour market there was unexpectedly robust during the crisis and the unemployment rate has now fallen to record lows. Tightness in the labour market is being translated into pressure on wages and so inflation risks.

There is no escaping that additional inflation in the emerging world could also be the end result of this combination of ultra-loose policy in the developed world and currency intervention in the emerging world, aggravated by food and energy-related inf- lation pressures and tighten- ing capacity constraints.

Philip Poole is global head of macro and investment strategy at HSBC Global Asset Management

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