Inflation rears its head at summit

Many pundits now feel the Chinese market crash and broader slowdown have made a September rise less likely. Photo / AP

Despite volatility and China’s plunge, world’s bankers expect old foe to return.

Inflation is not dead. That seems to be the consensus at the annual summit of the world's central bankers in Jackson Hole, Wyoming, at the weekend.

But while inflation, or its disappearance, was the official theme this year, there seems no doubt market volatility and the slowdown in China were top of mind for many.

Officials from the United States Federal Reserve, Bank of England and European Central Bank all indicated they expect inflation to re-emerge in the West as economic growth kicks back into gear.

US Fed vice-chairman Stanley Fischer told the summit there was "good reason to believe that inflation will move higher as the forces holding down inflation dissipate further".

But how soon and how fast that growth will emerge remains uncertain. Fischer was giving little away about the timing of US rate rises.

The issue comes to a crunch on September 16-17 when the Fed meets, with the market still broadly anticipating a September start date for interest rate rises.

That has big implications for the rest of the world, not least New Zealand where rising US rates should push up the value of the US dollar and cause ours to fall further.

But many pundits now feel the Chinese market crash and broader slowdown have made a September rise less likely.

A week on from China's "Black Monday", it's hard to know how much of a dampener it has been on global growth expectations.

After initial sell-offs, Wall St seemed to shrug off China's woes later in the week with strong GDP numbers for the US buoying investors.

How stocks fare in Shanghai will again be a key focus for markets this week but if the US continues to shrug off the volatility, fears of a global slowdown may ease.

Fischer told US media that before the turbulence in global financial markets, "there was a pretty strong case" for a September rate hike. But he indicated the issue was now less clear as fallout from the past week in China and on Wall St needed to be assessed.

The US dropped official interest rates to near zero (0.25) at the height of the Global Financial Crisis in 2008. With US inflation stuck below 2 per cent for more than three years, the Fed has been able to leave rates lower for longer than many had expected.

In New Zealand, rates had already started to rise before the crash of dairy prices prompted a turnaround from the Reserve Bank. Now at 3 per cent, they have been cut twice this year and the market is expecting two more cuts before the end of the year.

Despite our higher rates, the upward direction for rates in the US and downward direction in New Zealand is expected to put more pressure on the Kiwi dollar - a factor that could help drive an export recovery before the economy slows too much or even slips into recession.

With China's growth slowing and Europe still stagnating, the revival of US fortunes becomes all the more important for the global economy and export nations such as New Zealand and Australia.

Whenever the US Fed moves on rates, it will be a slow return to normality. But the first move will be hugely symbolic, signalling to the world that the US is back in business.

What happens on the markets this week will be key in determining how soon that signal comes.