Will the 'Cold War' Against Inflation Heat Up?

Another Federal Reserve Bank official said in a speech yesterday that he is: “taking the recent inflationary pressures very seriously,” and that “Policy needs to react decisively” to keep expectations of higher inflation in check.

So is this just more lip service from the Fed in an attempt to jawbone inflation (and perhaps support the dollar)? Financial markets aren’t so sure, as Fed funds futures continue to price-in a Fed rate hike sometime this year.

The major economies of the developed world are experiencing a sharp slowdown in growth, and bracing for recession. In fact, the U.S. economy expanded at a feeble rate of just 1% in the first quarter.

And we may have already entered recession, when data for the second quarter ended June finally gets reported.

But even as the economy slows, consumer price inflation in the U.S. rose to 4.2% in May, while wholesale prices rose 7.2%.

Meanwhile, emerging market economies continue to enjoy very robust economic expansion, expected to average 6.7% this year. That compares quite favorably to growth estimates of just 1.3% for developed countries including the U.S. and Europe (the U.S. will grow just 0.5%).

While inflation is running above the Fed’s comfort level in the U.S. (and the ECBs target in Europe), inflation in the emerging world has become an even bigger threat. In fact, inflation exceeds double-digit rates of 10% or more in 50 economies around the world, nearly all of them emerging markets.

This is an economic environment that looks shockingly similar to the “stagflation” era of the 1970’s and early 1980’s.

Famed investor Warren Buffett highlighted the dueling threats of slower growth and faster inflation recently saying: “I think the ‘flation’ part will heat up and I think the ‘stag’ part will get worse.”

While the Fed continues waging its war-of-words on inflation, the ECB gets to act on it tomorrow. Stay tuned.