That Siren You Hear Is The Inflation Alarm

Like thunder after lightning, inflation follows an economic growth spurt, right? It was certainly true in the 1970s and 1980s, but the 1990s are supposed to be different. On both sides of the Atlantic, central bankers throughout the year have pledged not to let inflation show its face and touch off another boom-and-bust cycle. But now that a turnaround is sweeping through Europe, there are worrisome signs that inflation is about to make a comeback. Central bankers are caught between making good on their low-inflation promises and supporting their countries' fledgling recoveries.

In the U.S., Federal Reserve Chairman Alan Greenspan raised the federal funds rate on Aug. 16 by half a point, to 4.75%, in response to rising commodity prices, a weak dollar, and manufacturers operating at near-capacity levels. Now, his European counterparts are poring over similar tea leaves and wondering if they should follow suit. "The world's economies have resynchronized," says Nomura International PLC analyst Nicholas Knight. "All the inflationary pressures are lined up in the same direction."

To Knight, that direction is up. He thinks Europe's marked acceleration in growth--especially Germany's surprise 2.5% forecast for 1994--means interest rates are headed up soon. Like Greenspan, he and other inflation bears see danger signals in the global commodity markets, where sudden jumps in demand have pushed up prices for such basic materials as pulp, steel, chemicals, lumber, and palm oil used in food processing. In addition, some manufacturers are running almost flat out: At Britain's Imperial Chemical Industries PLC, utilization is 90%.

So far, true inflation in the form of rapidly rising consumer prices isn't really a problem. National Westminster bank predicts yearend inflation rates of 2.2% in Britain, 2.9% in Germany, 1.8% in France, and 3.9% in Italy. But officials could get a big incentive to raise rates from labor, which is likely to demand a piece of the pie it helped bake. Unemployment is averaging 11.4% in Europe, but because of the labor unions' power in wage negotiations on the Continent, relatively high unemployment and wage inflation can coexist. Indeed, Europe has already seen sporadic rail strikes, and British workers are threatening to strike Midland Bank PLC. In Germany, the powerful IG Metall union says it wants real wage increases in 1995 after forgoing them this year.

Not all observers think the usual price spiral is imminent. Keith Wade, an economist with London-based J. Henry Schroder Wagg & Co., believes most European economies can grow comfortably at least another year before following in America's higher-interest-rate footsteps. Recent rate rises in Sweden and Italy were aimed at currency weakness, he argues. Still, the relentlessly strong results and bullish growth forecasts ensure that economists and central bankers will have their eyes glued to the numbers as the recovery roars on.

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