Will commodity price rises trigger inflation in 2018?

As we begin our journey into 2018 then there has been one clear trend so far as Bloomberg has pointed out this morning.

The Bloomberg Commodities Spot Index, tracking the price of 22 raw materials, jumped to its highest since December 2014 on Thursday. The gauge has risen for a record 14 days in a row.

If we take a look at the underlying data we see that the index has rallied from just below 340 on the 11th of December to 361 as I type this and it has been pretty much one-way traffic. So perhaps ripe for a correction in the short-term but if we look further back we see that it is up 8% on a year ago and that this stronger phase began just under 2 years ago in mid January 2016 when the index dipped below 255. This leaves us with an intriguing conclusion which is that the commodities index saw a strong rally in 2016 just as we were being told inflation was dead as mainstream analysis looked back on the previous downwards trend.

Bloomberg is upbeat on the causes of this recent phase.

The strongest manufacturing activity since the aftermath of the global financial crisis is slowly draining commodities surpluses, sending prices to a 3-year high as investors pour money into everything from oil to copper.

“Rarely has the outlook for a New Year been as encouraging as it is today,” said Holger Schmieding, chief economist at Berenberg Bank in London.

With factories around the world humming, demand for raw materials is fast increasing.

That is an upbeat way of looking at the issue although of course it omits something that in other articles they tell us is important which is the use of finite resources. We get however a clue to their emphasis from this.

Where to make Big Money in Commodities, Energy

I particularly like the way that Big Money is in capitals. Anyway well done to those who had stockpiled commodities. Also there may be a misprint about the chief economist of Berenberg Bank being in London as of course Bloomberg readers will have been told that all such jobs have gone to Frankfurt although they may be further confused by the brand new shiny Bloomberg offices in London! Moving to the Financial Times we also see that good economic news is on their minds.

Markit’s global survey of manufacturing activity rose to a near seven-year high in December, fuelling optimism that 2018 could be another year of strong growth.

Crude Oil

The rally here poses something of a problem for economics/finance themes because as regular readers will recall we were told that the advent of shale oil production would prevent price rises. One part of the analysis was true in that they have indeed produced more oil.

The U.S. Energy Information Administration (EIA) expects U.S. crude oil production to have averaged 9.2 million bpd for all of last year. It expects U.S. crude oil production to average an all-time high of 10.0 million bpd this year, which would beat the current record set in 1970. ( OilPrice.com)

That is of course more than awkward for those who put Peak Oil theories forwards in the 1970s for a start. Moving back to the current oil price what was not forseen was that OPEC will not only announce production cuts but actually go through with the announcements leading to this.

however, oil prices rose steadily in the fourth quarter of 2017 to end the year at above $60 per barrel WTI and $66 per barrel Brent.

Brent Crude Oil nudged over US $68 per barrel earlier today or as high as it has been for two and a half years. At such a level we see that there is good news for oil producers of all sorts.Firstly there must be something of a bonanza for the shale oil producers with the cash flow style business model we have previously analysed. But also there will be all sorts of gains for the more traditional oil producers in the Middle East as well as Canada and Russia. There has been an irony in that the pipeline shutdown for the UK Forties field meant that Brent production could not benefit from higher Brent prices but that is now over.


Last September an International Monetary Fund ( IMF) working paper looked at how oil price moves affected inflation.

 We find that a 10 percent increase in global oil inflation increases, on average, domestic inflation by about 0.4 percentage point on impact, with the effect vanishing after two years and being similar between advanced and developing economies.

There was also some support for those who think that the effect is stronger when prices rise.

We also find that the effect is asymmetric, with positive oil price shocks having a larger effect than negative ones

The results also vary from country to country as the impact on the UK is double that of the impact on the United States although this may be influenced by 1970s data when the UK Pound £ would have acted like the Great British Peso on any oil price rise.

As an aside I would like to remind everyone of the way a surge in the oil price contributed to the economic effects of the credit crunch, something which tends to get forgotten these days. On that road the credit crunch era becomes easier to understand and the establishment mantra which this IMF paper repeats becomes more questionable.

The has declined over time, mostly
due to the improvement in the conduct of monetary policy.

A darker road can be found if we look at the impact of bank commodity trading desks back then because if as I believe they drove oil prices higher there is a raft of questions to add to the other scandals we have seen such as Li(e)bor and foreign exchange rigging.


There has been a raft of news about these hitting new highs and let us start with what Dr,Copper is telling us.

Copper gained 30%  in 2017 as it continues to recover from six-year lows struck early last year……… Measured from its multi-year lows struck at the beginning of 2016, copper has gained more than 70% in value. ( Mining.com)

Palladium has been hitting all-time highs this week. If we look deeper we see that metals prices have been rising overall as the CRB metals index which was conveniently at 800 this time last year is at 912 as I type this.


There are various factors to consider here but let me open with a word not in frequent use in the credit crunch era which is reflation. We are seeing a stronger economic phase ( good although there is the underlying finite resources issue) but how much of this higher demand will feed into inflation may be the next question? There have been signs of Something Going On as Todd Terry would put it. From the Composite PMI or business survey for the Euro area.

The pace of inflation signalled for each price
measure remained strong relative to their long-run
trends, however, and among the steepest seen over
the past six-and-a-half years.

Also for the UK services sector.

Input price inflation reached its highest level since
last September, with service providers noting
upward pressures on costs from a wide range of

Moving to a different perspective some seem to be placing their betting chips in the US according to the Financial Times.

Investors pour money into funds that protect against inflation

Also there will be wealth and GDP shifts in favour of commodity producers and from those that consume them. The obvious beneficiary is much of the Middle East but others such as Australia, Canada and Russia will be smiling and that is before we get to the US shale oil producers who have been handed a lifeline. It also reminds me that the Chinese effort to get control of commodities around the world and particularly in Africa looks much more far-sighted than us western capitalist imperialists have so far managed. That is something which will particularly annoy Japan which of course is a large loser as commodity prices rise due to its lack of natural resources as its own more violent and aggressive efforts in this field badly misfired in the 1940s.


The ECB “taper” meets “To infinity! And beyond!”

Yesterday was central banker day when we heard from Mark Carney of the Bank of England, Mario Draghi of the ECB and Janet Yellen of the US Federal Reserve. I covered the woes of Governor Carney yesterday and note that even that keen supporter of him Bloomberg is now pointing out that he is losing the debate. As it happened Janet Yellen was also giving a speech in London and gave a huge hostage to fortune.

Yellen today: “Don’t see another crisis in our lifetimes” Yellen May 2016: “We Didn’t See The Financial Crisis Coming” ( @Stalingrad_Poor )

Let us hope she is in good health and if you really wanted to embarrass her you would look at what she was saying in 2007/08. However the most significant speech came at the best location as the ECB has decamped to its summer break, excuse me central banking forum, at the Portuguese resort of Sintra.

Mario Draghi

As President Draghi enjoyed his morning espresso before giving his keynote speech he will have let out a sigh of relief that it was not about banking supervision. After all the bailout of the Veneto Banks in Italy would have come up and people might have asked on whose watch as Governor of the Bank of Italy the problems built up? Even worse one of the young economists invited might have wondered why the legal infrastructure covering the Italian banking sector is nicknamed the “Draghi Laws”?

However even in the area of monetary policy there are problems to be faced as I pointed out on the 13th of March.

It too is in a zone where ch-ch-changes are ahead. I have written several times already explaining that with inflation pretty much on target and economic growth having improved its rate of expansion of its balance sheet looks far to high even at the 60 billion Euros a month due in April.

Indeed on the 26th of May I noted that Mario himself had implicitly admitted as much.

As a result, the euro area is now witnessing an increasingly solid recovery driven largely by a virtuous circle of employment and consumption, although underlying inflation pressures remain subdued. The convergence of credit conditions across countries has also contributed to the upswing becoming more broad-based across sectors and countries. Euro area GDP growth is currently 1.7%, and surveys point to continued resilience in the coming quarters.

That simply does not go with an official deposit rate of -0.4% and 60 billion Euros a month of Quantitative Easing. Policy is expansionary in what is in Euro area terms a boom.

This was the first problem that Mario faced which is how to bask in the success of economic growth whilst avoiding the obvious counterpoint that policy is now wrong. He did this partly by indulging in an international comparison.

since January 2015 – that is, following the announcement of the expanded asset purchase programme (APP) – GDP
has grown by 3.6% in the euro area. That is a higher growth rate than in same period following QE1 or QE2 in the United States, and a percentage point lower than the period after QE3. Employment in the euro area has also risen by more than four million since we announced the expanded APP, comparable with both QE2 and QE3 in the US, and considerably higher than QE1.

You may note that Mario is picking his own variables meaning that unemployment for example is omitted as are differences of timing and circumstance. But on this road we got the section which had an immediate impact on financial markets.

The threat of deflation is gone and reflationary forces are at play.

So we got an implicit admittal that policy is pro-cyclical or if you prefer wrong. A reduction in monthly QE purchases of 20 billion a month is dwarfed by the change in circumstances. But we have to be told something is happening so there was this.

This more favourable balance of risks has been already reflected in our monetary policy stance, via the adjustments we have made to our forward guidance.

You have my permission to laugh at this point! If he went out into the streets of Sintra I wonder how many would know who he is let alone be running their lives to the tune of his Forward Guidance!? Whilst his Forward Guidance has not been quite the disaster of Mark Carney the sentence below shows a misfire.

This illustrates that core inflation does not
always give us a clear reading of underlying inflation dynamics.

The truth is as I have argued all along that there was no deflation threat in terms of a downwards spiral for inflation because it was driven by this.

Oil-related base effects are also the main driver of the considerable volatility in headline inflation that we have seen, and will be seeing, in the euro area………. As a result, in the first quarter of 2017, oil-sensitive items  were still holding back core inflation.

I guess the many parts of the media which have copy and pasted the core inflation/deflation theme will be hoping that their readers have a bout of amnesia. Or to put it another way that Mario has set up a straw (wo)man below.

What is clear is that our monetary policy measures have been successful in avoiding a deflationary spiral and securing the anchoring of inflation expectations.

Actually if you look elsewhere in his speech you will see that if you consider all the effort put in that in fact his policies had a relatively minor impact.

Between 2016 and 2019 we estimate that our monetary policy will have lifted inflation by 1.7 percentage points,

So it took a balance sheet of 4.2 trillion Euros ( and of course rising as this goes to 2019) to get that? You can look at the current flow of 60 billion a month which makes it look a little better but it is not a lot of bang for your Euro.

Market Movements

There was a clear response to the mention of the word “reflationary” as the Euro rose strongly. It rose above 1.13 to the US Dollar as it continued the stronger  phase we have been seeing in 2017 as it opened the year more like 1.04.  Also government bond yields rose although the media reports of “jumps” made me smile as I noted that the German ten-year yield was only 0.4% and the two-year was -0.57%! Remember when the ECB promised it was fixing the issue of demand for German bonds?


On the surface this is a triumph for Forward Guidance as Mario’s speech tightens monetary policy via higher bond yields and a higher value for the Euro on the foreign exchanges. Yet if we go back to March 2014 he himself pointed out the flaw in this.

Now, as a rule of thumb, each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points.

You see the effective or trade-weighted index dipped to 93.5 in the middle of April but was 97.2 at yesterday’s close. If we note that Mario is not achieving his inflation target and may be moving away from it we get food for thought.

Euro area annual inflation was 1.4% in May 2017, down from 1.9% in April.

So as the markets assume what might be called “tapering” ( in terms of monthly QE purchases) or “normalisation” in terms of interest-rates we can look further ahead and wonder if “To infinity! And Beyond!” will win? After all if the economy slows later this year  and inflation remains below target ………

There are two intangible factors here. Firstly the path of inflation these days depends mostly in the price of crude oil. Secondly whilst I avoid politics like the plague it is true that we will find out more about what the ECB really intends once this years major elections are done and dusted as the word “independent” gets another modification in my financial lexicon for these times