Global inflationary pressure has investors demanding government bonds as protection against rising prices. For nearly nine months, inflation rates have become increasing heavy on the world economy and investors are worried that some governments cannot sustain any strength that is needed for prolonged economic recovery.
Not since 1991, when the European Union first experienced a historically high inflation rate of 5 percent, has the euro zone nations faced another tough inflationary challenge to it economic well being, and for emerging markets like China, India, and Brazil the threat of inflation is also felt. Globally-speaking, rising prices in food, oil, energy, retail, and raw materials are hindering recovery. This impact could further cause prices to rise “over the next few years with some warning that inflation could be the world’s next economic pressure point,” as reported by Financial Times.
The risk of inflation typically happens when fast-growing emerging economies struggle to keep up with the pace of consumer prices, but, now well-developed countries- like Great Britain- are facing the risk of inflation as well, leaving investors to decide if the risk outweighs the growth rate.
In Europe, annual inflation for 2010 was 2.2 percent, up from 0.9 percent the year before. The UK, in particular, faces an even harder economic downfall. Inflation has reached a record high of 3.7 percent with projections expecting an even higher rate to come forcing the Bank of England to consider raising interest rates. However, European Central Bank President Jean-Claude Trichet said he’s prepared to raise interest rates if needed in order to fight inflation, but noting that “higher interest rates would saddle debt-laden countries such as Ireland, Greece and Portugal with still higher borrowing costs.” (Bloomberg) As it stands, the inflation rates for Ireland, Greece and Portugal are: 1.3%, 5.2%, and 2.6%, respectfully.
The International Monetary Fund categorizes Europe (as well as Asia) as either advanced or emerging; within the advanced group, are nations in either the euro “zone” or out. Accordingly, the IMF determined in its World Economic Outlook for 2010, that in advanced Europe, inflation expectations are “well anchored” by large output gaps from the various countries, and within the emerging Europe, inflation prospects are mixed with “different exchange rate regimes and varying degrees of economic slack.”
Europe, overall, faces many challenges mainly due to exposure to risky sovereign debt. However, the IMF suggests that, “The crisis exposed long-standing problems in existing fiscal, structural, and financial stability policies. Such weaknesses need to be addressed in order to ensure Europe’s future stability and growth.” But, divergences amongst euro-region economies make financial stability difficult.
While Europe is facing slow and/or strained economic growth, Asia is experiencing the reverse.
Domestic demand and rebounding exports are the driving forces behind the skyrocketed growth. In China, the annual GDP growth was 10.3 percent for 2010 and is expected to average at 9.6 percent for 2011. India, on the other hand, grew at a rate of 8.5 percent in 2010 and is projected to be 8.4 percent for 2011. For several years now, these markets have tremendously progressed thanks to global trade, and as a result, the residual effects are an inflated economy. Currently, China’s rate of inflation is 4.6 percent and India’s inflation rate is 8.3 percent.
The IMF feels that China and India need to adopt a fiscal policy of one that will “unwind stimulus” as a measure of economic recovery. As of late, the Reserve Bank of India raised interest rates for the seventh time in less than a year to curb spikes in food-related prices; in 2010 the annual food price for India rose 14 percent. The People’s Bank of China, however, maintains the monetary policy of “dumping” its large US dollar reserves into other markets, at the same time, requiring its banks to raise the amount of money it has in reserves (because of these steps to reduce inflation, this is why GDP is expected to lower).
And, as far as Latin America is concerned, it is experiencing hyperinflation. While no stranger to this economic phenomenon, South America has dealt with this many times over and still maintains a level of prosperity. However, countries such as Peru, Bolivia, and Chile are experiencing low inflation rates despite its neighboring economies. “All in all, Latin America is expected to see an average inflation of 5.5 percent in the 2011-15 period, which is higher than the global average of 3.7 percent,” according to the Latin Business Chronicle.
Brazil’s inflation reached 5.91 percent in 2010, the highest in six years, and the rate of interest for the largest South American country is 11.25 percent. Argentina’s inflation rate is 10.9 percent and leading the way is Venezuela with an exorbitant 24.5 percent inflation rate. The inflation rates for Ecuador, Colombia, Mexico, Uruguay, and Paraguay, respectively are: 3.6%, 2.6%, 4.1%, 6.8%, and 4.2%.
Overall economic recovery is slow and staggered, but, encouraging. In the mean time, for investors, sovereign securities are becoming more and more attractive. Recently, the euro zone government bail-out fund, known as the European Financial Stability Facility, received high demand from central banks and institutional investors in its debut issue- further evidence that inflation-adjusted securities are the preferred investment vehicle for hedging against inflation risk.
Furthermore, the Global Investment Committee of Morgan Stanley Smith Barney stated in a December 2010 report that, “Given [the] global outlook, the GIC recommends that investors position their portfolios by overweighting [fast-growing emerging economies] equities, investment-grade and high yield bonds and alternative/absolute return investments such as commodities, inflation-linked securities and real estate investment trusts (REITs).” Doing so will lighten the investment risk load as the world recoup from inflationary woes.
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