My finance view

U.S. and European central bankers are intensifying pressure on counterparts in emerging-market countries to step up the fight against inflation.

Federal Reserve Vice Chairman Donald Kohn yesterday urged countries where “rapid'' economic growth is elevating prices to respond. Hours earlier, Bank of England Governor Mervyn King said global monetary policy looks “a little lax.'' Bank of France Governor Christian Noyer said the day before that “coordinated, resolute action'' is needed to encourage more exchange-rate flexibility as a way of tackling inflation.

The comments reflect concern among central banks in major industrialized economies that their own campaigns against inflation will be undermined by a failure of others to combat price pressures. Demand in emerging markets is already propelling the cost of commodities such as oil, tin and corn to records.

“The bulk of inflation is coming from emerging markets,'' said Stuart Green, a global economist at HSBC Holdings Plc in London. “The concern in developed economies is that inflation is rising because of pressures outside of their remit and that monetary policy overseas is too loose.''

Morgan Stanley economists calculate about a quarter of the world's economies, representing 42 percent of its population, have “double-digit'' inflation. Almost all are emerging markets. Consumer prices in Vietnam jumped 26.8 percent in June, the biggest annual increase since 1992, data showed yesterday.

`Excess Demand'

“Many suspect that excessive economic policy in major emerging-market nations is causing excess demand for commodities globally,'' said Ashley Davies, a currency strategist at UBS AG in Singapore. Crude oil rose to a record above $1.42 a barrel this week and corn prices climbed to an unprecedented level.

Some central banks are starting to act. Those in Romania, Russia, Brazil, Egypt, Mexico, Chile, Taiwan, the Philippines and India all raised their key interest rates this month. Still, a majority of emerging economies have benchmark rates below the rate of inflation, resulting in negative real interest rates. Morgan Stanley estimates inflation of 5 percent globally compared with an interest rate of 4.3 percent.

Dow Chemical Co. said this week it will raise prices by as much as 25 percent in July to compensate for higher raw-material costs. Rival chemical maker BASF SE also plans to increase prices by as much as 20 percent.

“In those countries where strong commodity demands are associated with rapid growth in aggregate demand that outstrips potential supply, actions to contain inflation by restraining aggregate demand would contribute to global price stability,'' Kohn said in a speech in Frankfurt electronic check payday advance. King told U.K. lawmakers that “the biggest challenge'' for central banks is “trying to ensure a monetary policy framework for the world as a whole that doesn't build into it an excess inflationary impetus.

Dollar Peg

The officials all identified the policy of some Asian governments of linking their currencies to the dollar as a potential source of inflation. Such a practice risks increasing prices as they pursue the same monetary policy as the Fed even while their domestic economies may require higher interest rates.

“By maintaining too tight a peg to the dollar, some countries are led to largely import the U.S. monetary policy, which is often totally unsuited to their economic situation,'' Noyer, who also sits on the European Central Bank's Governing Council, said in an annual report to his government. “This may result in inflationary pressures that are difficult to contain, which then tend to spread to the rest of the world.''

China, Gulf Currencies

While China dropped a peg to the dollar in July 2005, it limits trading in the yuan against the dollar even as inflation is close to its strongest since 1996. In Hong Kong, where the currency is tied to the dollar, producer prices jumped by the most on record in the first quarter.

Gulf states, including Saudi Arabia and the United Arab Emirates, have been under pressure to follow Kuwait and drop their pegs. They have all kept their links, citing the need to keep currencies fixed until they form a monetary union in 2010, and the limited inflationary impact of the weak dollar.

David Hensley, director of global economic coordination at JPMorgan Chase & Co., said the response of emerging-market policy makers may determine how far the major central banks have to raise their own interest rates to pare inflation.

ECB officials have signaled they will raise their main rate by a quarter point to 4.25 percent on July 3 amid the fastest inflation in 16 years. The Fed's Open-Market Committee on June 25 ended a series of seven rate cuts since September and said “upside risks'' to prices have picked up. The Bank of England is now also considering whether it must raise rates to curb inflation. Central bankers convene on June 30 in Basel, Switzerland, for a meeting of the Bank for International Settlements.

Economists at Morgan Stanley say emerging markets may still not do enough to slow inflation because they want to protect growth and prevent their currencies from soaring.

“A massive global tightening of monetary policy is unlikely,'' the economists said in a June 25 report.

Source