US and China on inflation watch this week

There are two important reports on inflation in January this week. One is for the United States, due out on Wednesday. Before that, however, we are due to get the inflation report from China on Tuesday.

According to a Bloomberg survey, the consensus estimate for US inflation sees consumer prices rising 4.2 percent in the year to January. Consumer prices excluding food and energy are expected to have risen 2.4 percent over the same period.




This suggests that the moderation in inflation in the US that began around the middle of 2006 has stalled for the time being. In fact, it may even be re-accelerating.

Nevertheless, most economists think that inflation will head downwards again at some point in the near future. This is based on expectations of an economic slowdown in the US over the coming months.

However, aggressive interest rate cuts in recent months by the Federal Reserve could be setting the stage for an upturn in inflation again further out into the future. A measure of expectation for inflation over the next ten years using the difference in yields between nominal Treasury notes and Treasury inflation-protected securities shows that expected inflation has been rising in recent months.

A report on import prices on Friday also gave a hint of the underlying inflationary pressures around the globe. The Labor Department reported that import prices rose 1.7 percent in January. This was largely due to petroleum imports, but even excluding the latter, import prices were up 0.6 percent from the previous month.

What also seemed noteworthy from the Labor Department report was that prices of imports from China rose 0.8 percent, the largest monthly increase since the index was first published in December 2003, and were up 3.3 percent over January 2007. China has often been seen as a source of disinflation for the rest of the world. If so, however, its role in curbing global consumer price inflation may be coming to an end.

One reason for the rising inflationary pressures from China is that China itself is facing inflationary pressures of its own. According to a Bloomberg survey, China's consumer prices are estimated to have risen 7 percent in January from a year earlier.

Other recent data highlight the inflationary pressures in China. Last week, the People's Bank of China had reported that M2 money supply rose 18.9 percent from a year earlier, accelerating from December's 16.7 percent rise. Today, the National Bureau of Statistics reported that producer prices rose 6.1 from a year earlier in January, again an acceleration from a 5.4 percent rise in December.

Therefore, the PBC will probably have to raise interest rates further this year.

Additionally, the renminbi will have to bear its share of the tightening burden and is likely to see further appreciation. In fact, with the Federal Reserve's rate cuts putting downward pressure on the US dollar, the renminbi may have to appreciate at a faster rate to offset the weakening US currency.

And the renminbi certainly has scope to rise against other currencies. As it is, while the Chinese currency has appreciated against the US dollar over the past few years, it has depreciated against the euro such that its exchange rate with the latter is now roughly back to what it was before it was depegged from the US dollar in 2005.