Global Inflation Will Put Brakes On World Economy: Henderson

Source : The Business Times, June 24, 2008

Rising food and oil prices due to supply shortage

MOVE over 'credit crunch', the latest catchphrase of doom is 'global inflation'.

According to Henderson Global Investors, global inflation, fuelled by rising oil and food prices, will put the brakes on the global economy in the near future.

'Global inflation is now at 6 per cent, and we expect it to become even higher than that,' said Tony Dolphin, director of economics and asset allocation at Henderson, an independent asset manager of US$117.8 billion worth of assets.

Mr Dolphin said that the twin threats of soaring food and oil prices stemmed from the inability of supply to meet demand, as well as loose monetary policies.

'Monetary policies have been lax, particularly in developing and emerging economies, which led to rapid economic growth - the strongest since the early 1970s. Despite tightening labour markets, wage inflation remained under control, but the price of commodities has risen as producers could not keep up with demand,' Mr Dolphin explained.

With oil prices on the rise, he reckons that global growth is bound to slow down.

'The world can't increase its oil supply fast enough for China to keep growing at 12 per cent a year and for the world to keep growing at 5 per cent a year,' he said.

While financial markets are expected to remain volatile, there remain some safe havens for investors seeking respite from inflation, especially in Japanese equities.

'Inflation in Japan is at its peak of just over one per cent and has the least to fear from rising food and energy prices,' said Mr Dolphin, who recommended a strategy of being overweight in Japan, equity-wise.

Also, it appears to be one of the least vulnerable countries where oil price hikes are concerned, given its energy efficiency.

'Despite Japan's economy's under-performance, its equities have been in line with the developed markets,' said Mr Dolphin.

This is in stark contrast to Europe, where the fund recommends an underweight strategy for equities.

'The Europe market is quite vulnerable to inflationary pressures. And the strength of the euro will have detrimental effects on the earnings of its exporting companies,' he said.

Even so, equities are not the safest hedge against inflation.

'While inflation can lead to higher earnings being reported for firms, even higher inflation causes the quality of earnings to deteriorate, because it is uncertain whether it is good fundamentals or inflation driving higher earnings,' Mr Dolphin said.