Emerging Markets: The ‘three key sources of inflationary pressure’

9th February 2011

Philip Poole, Global Head of Macro and Investment Strategy, says emerging market investors should take out some inflation insurance using inflation linked bonds and other strategies.

 "It is in the emerging not the developed economies where the inflation threat is still most pronounced," he says.

"With headline inflation already well above previous mid-cycle levels in a number of key emerging economies and with little sign of pressures moderating, there is a question of whether the authorities' are falling behind the curve, creating future risks for investors."

Poole points out that Russian Inflation rose 2.4 per cent month on month in January up from 1.1 per cent in December while annual inflation rose from 8.8 per cent to 9.6 per cent.

The firm says that higher inflation may be becoming entrenched in commodities and services yet the Central Bank of Russia has refused to increase rates "delaying the inevitable".

Poole identifies three key sources of inflationary pressures.

In China and India food price inflation is a problem reflecting local and global disruptions in supply. In addition food is often a dominant component of Consumer Price Inflation in emerging markets with weightings as high a 40 per cent compared with around 15 per cent in Europe and the US.

In addition, due to US quantitative easing, many emerging market central banks are buying dollars to cap currency appreciation but this could ultimately lead them import inflation and bring about appreciation through the back door.

He also warns about wage inflation. It says: "The labour market could be an important transmission channel for inflation pressures in a number of these economies. If real wages grow at a faster pace than productivity and the result is passed through to product markets, inflation pressures will increase. Brazil remains a good example; the labour market there was unexpectedly robust during the crisis and the unemployment rate has now fallen to just 5.3%, a record low."

Poole suggests that investors should buy some inflation protection via inflation-linked securities while these are, in his view, still affordable. He warns of duration risk in bond holdings because the yield curve is likely to steepen. He also suggests avoiding interest rate sensitive sectors and companies.

SEE ALSO: Are emerging markets past their prime? A conversation with Philip Poole


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