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Inflation Fear Passing Spurs Central Banks’ Recession Focus

The global inflation scare is ending.

As faltering economic growth drags down food and energy costs, consumer prices are climbing more slowly after jumping earlier this year. JPMorgan Chase & Co. economists calculate the worldwide inflation rate will slide on an annual basis to just over 3 percent by the end of the year from 3.7 percent in June, when most central bank targets were breached.

The likelihood of weaker price pressures, which will be debated today at a Bloomberg Link conference in New York, may help extend the three-decade rally in global bonds, with U.S. Treasuries already rising last month by the most since December 2008. It also is allowing central banks from Canada to Sweden and Australia to keep monetary policy loose to bolster global growth under threat from Europe’s fiscal crisis and the U.S. slowdown.

“We’re getting a reprieve from inflation,” said Edward Yardeni, president and chief investment strategist at Yardeni Research Inc. in New York, who will speak at the conference and who devised the term “bond vigilantes” to describe the power financial markets can wield over governments. “On balance, it will keep bond yields relatively low.”

Inflation-Protected Securities

Investors are starting to anticipate weaker price pressures. Breakeven rates on U.S. Treasury Inflation-Protected Securities, or TIPS, are hovering near the lowest since October 2010. The breakeven inflation rate, calculated from yield differences on 10-year Treasury notes and inflation-indexed U.S. government bonds of similar maturity, has fallen to 1.98 percent from a 2011 high of 2.66 percent on April 11.

Five-year breakevens for the U.S., Germany and France are all under 1.7 percent, indicating little inflation concern in the coming half-decade, while those for Japan remain negative. Inflation-linked government bonds worldwide underperformed nominal sovereign debt last month by 1.282 percentage points, the most since February 2009, according to Bank of America Corp. indexes.

European Central Bank President Jean-Claude Trichet said today that threats to the euro region’s economy have “intensified” and inflation risks have eased as the region’s debt crisis worsens. The ECB left its benchmark rate at 1.5 percent and cut growth forecasts for this year and next. Bank of England held its key rate at a record low of 0.5 percent today.

“We’re looking at a situation when the main risk is of very soft price increases rather than runaway inflation,” said Constance Hunter, chief economist at Aladdin Capital Management LLC in Stamford, Connecticut, which oversees $12 billion. Hunter will also address the Bloomberg conference.

Supporting Growth

Central bankers are already taking advantage of that outlook to focus more on supporting growth as the world economy loses momentum and financial markets are roiled by the euro-area’s failure to contain its debt crisis. Those from the Group of Seven will debate the world economy when they begin convening for talks in the French city of Marseille tomorrow.

Yesterday alone, the Bank of Canada said there is a “diminished” need for it to raise interest rates, Sweden’s Riksbank abandoned a planned rate increase and Reserve Bank of Australia Governor Glenn Stevens signaled he’s prepared to extend a pause in rate shifts. The Czech central bank also may delay boosting borrowing costs if the euro area’s turmoil escalates, board member Lubomir Lizal said in an interview. The Bank of Japan kept monetary policy unchanged as it gauges the effect of stimulus.

Behind the revaluation of inflation risks is weakening economic growth that is pulling down the prices of energy and food. Crude oil traded in New York has dropped to $90.11 a barrel from $113.73 in April. The Standard & Poor’s GSCI Spot Index of 24 raw materials has dropped about 12 percent from its highest level in almost three years in April, while the United Nations’ Food and Agriculture World Food Price Index has fallen 1.6 percent from a record in February.

Forces Compounded

With such forces compounded by high unemployment and weak credit growth, “inflation in advanced economies should drop back to very low levels by late 2012,” said Andrew Kenningham, an economist at Capital Economics Ltd. in London.

Inflation will stay low for years, at least in rich nations, said Larry Hatheway, chief global economist at UBS AG in London. That’s because sustained price increases are a product of excess demand, and economic growth rates in France, the U.S. and the U.K. are running more than 3.5 percentage points below long-term trend rates, he calculates.

“It will take years before output gaps are closed,” Hatheway said. “That’s not conducive to higher inflation anytime soon.”

Profit Target Cut

Companies are responding. Wal-Mart Stores Inc., the world’s largest retailer, is “laser focused” on prices as customers switch to cheaper goods and smaller packages, Chief Executive Officer Michael T. Duke said Aug. 16. France’s Carrefour SA, the No. 2 retailer, said Aug. 31 it will “reset” prices in its home country, its biggest market, in a bid to revive earnings after cutting its annual profit target.

Other central banks may also be shifting their focus back to growth after growing wary of inflation earlier in the year.

Federal Reserve Chairman Ben S. Bernanke, in his Aug. 26 speech at the central bank’s Jackson Hole, Wyoming, economic symposium, said the Fed still has tools to boost growth. Policy makers debated those options, including a third round of asset purchases, last month and will do so again at an expanded two-day meeting ending Sept. 21. Another option is to reduce borrowing costs by replacing short-maturity Treasuries in its $1.65 trillion portfolio with long-term bonds.

Chicago Fed President Charles Evans, who votes on monetary policy this year, yesterday called for “very significant amounts” of added stimulus and allowing inflation to drift temporarily as high as 3 percent.

Reviewing Assessment

Trichet said Aug. 29 that his bank is reviewing its assessment of inflation risks after raising its benchmark rate twice this year, to 1.5 percent, and saying Aug. 3 that price risks were “on the upside.”

At the Bank of England, two policy makers who previously sought higher interest rates last month voted to keep them unchanged, and officials are now considering more stimulus. The ECB and Bank of England both hold policy meetings today.

Inflation remains the chief concern of central bankers in Asia’s emerging markets, according to Johanna Chua, Hong Kong-based chief economist for Asia at Citigroup Inc. Chinese inflation accelerated to a three-year high of 6.5 percent in July, prompting Premier Wen Jiabao to say Aug. 31 that his top economic priority is stabilizing prices. India’s wholesale price index gained 9.22 percent in July.

‘Sticky’ Inflation

“Inflation in some Asian countries remains sticky and thus given that rates are still historically low, policy makers in Asia will be cautious in easing monetary policy too quickly,” Chua said.

Inflation in the advanced nations may still also pick up once economic recoveries take hold given the amount of liquidity that authorities have injected into their economies, said Axel Merk, president and chief investment officer at Merk Investments LLC in Palo Alto, California, and a Bloomberg Link speaker.

“Policy makers can print as much money as they can for now, but consumers don’t want it,” he said. “But we see inflation creeping up at the edges in commodities, and if we do get growth then it will become a bad concern. Saying there are no inflation fears is dangerous.”

At the same time, the change in tone from developed countries’ central banks has prompted Torsten Slok, chief international economist at Deutsche Bank AG, to predict major central banks will hold off tightening monetary policy for the remainder of this year.

“Inflation shouldn’t be a problem going forward, so interest rates will be low for even longer,” said Slok, another speaker at the Bloomberg Link conference.

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