The world’s central bankers have been tricked by a period of exported deflation to believe that it is easy to hit inflation targets, according to Societe Generale’s Brian Hilliard.
Hilliard argues that China has been exporting deflation to the Western world since its growth really started to kick-off in the 1990s. Deflation was exported through lower prices for goods, achieved through lower wages and input prices.
From Brian Hilliard:
As China emerged onto the world economic stage, it drove down the global price of industrial goods steadily year by year as its low cost production base allowed it to flood western markets with cheap exports. This deceived western central banks into believing that their new policy toy of inflation targets was working well as inflation rates stayed well under control. Essentially, they were receiving a gift of low inflation from China but instead they thought that low domestic inflation was the result of their own domestic policy actions.
Now that the development of China has accelerated, two important changes have occurred in that country. First, it has become hungrier for commodities, driving up their prices globally. Second, domestic labour costs have started to accelerate with the result that the export prices of Chinese goods have done the same. These factors are combining to create a potent force for rising inflation pressures around the world. This is why we are seeing the acceleration of import prices in the UK, for example.
Hilliard argues that the Bank of England needs to increase its target rate of 2% inflation, but can’t do so until it brings the rate of inflation down to that level, without risking its credibility. Inflation is currently at 4.0%, and Hilliard doesn’t expect it to hit that 2% target until the end of 2012.