INFLATION AND INVENTORY

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    AUSTRALIAN INFLATIONARY EXPECTATIONS:

    According to this afternoon's Ferret's Bourse Beat, the Melbourne Institute is reporting the outcome of its October 2002 survey of consumers.

    According to the survey, consumers "expect inflation will hit 5 per cent".

    2 immediate points to note:
    1)
    this is "considerably higher than the real current rate" and suggests an inflation uplift (ie: at least in the headline rate of ~2.5%, and in the "core" rate of ~3%); and
    2)
    inflationary expectations are growing (not diminishing) with those surveyed in October expecticng a higher rate of inflation going forward than those who were surveyed in September.

    Analysing this, Bourse Beat queried whether the expectation was realistic.

    In response to his Kieran Davies, the chief economist at ABN Amro commented:

    "I think there are probably some price rises coming through.....(t)here probably is some rebuilding of margins going on as the domestic economy is pretty buoyant outside the farm sector.....Food prices are starting to trend higher because of the drought.....Next week's CPI figures will probably show that .... Unemployment expectations data out today shows an improvement."

    Queried further on this, Davies was asked "what is the usual policy response to:
    1)
    lower unemployment;
    2)
    rising food prices; and
    3)
    improving margins?

    According to Davies:

    "Ordinarily, the reaction to higher inflation would be higher interest rates but in the current circumstances, the Reserve Bank is more concerned about what's happening offshore".


    GLOBAL INVENTORY LEVELS:

    Elsewhere, Merrill Lynch has commented on the question of global inventory levels, noting that current inventory levels are quite keenly pitched (ie: little buffer in store meaning that any improvement in demand will quickly translate into increased production orders and /or component bottlenecks).

    Commenting on this, Merrill Lynch observed the following on 15/10/02 (attribution to Matthew Higgins, Senior International Economist):

    "Survey data for the manufacturing sector has been very disappointing over the last couple of months. The IFO has dropped sharply, the ISM index is now below 50 and the Q3 Tankan survey showed marginal improvements from a low base.

    "Worse, the forward-looking components for each of these indices suggest that the manufacturing sector will probably remain sluggish over the next couple of months. Will the
    manufacturing sector take another leg down?

    "Our best bet is that things will get slightly better by year-end, not worse. The reason? Unlike 2001, inventories are now at drum-tight levels across the globe. In the U.S., for example, most sectors are at or near record-low inventory to shipment ratios (Table 1, page 2).

    "Further, there is no indication that companies are dissatisfied with their inventory levels (Chart 1). That means new orders will likely translate into production. Shy of a double dip recession, a manufacturing meltdown is highly unlikely.

    "Interestingly, production levels in the U.S. and Japan are far below those achieved at the beginning of 2000, whereas the reverse is true for Euroland.

    "The take away point from this observation is that once the global economy recovers, there will be more room to run in the U.S. and Japan than in Euroland".


    CONCLUSION:

    Whilst globally we still have manufacturing capacity available with which to capture any increases in production /demand, the reality is that we do not have inventory stockpiles in place with which to meet demand.

    The risks associated with this, therefore, translate to demand inflation given that there will be a time delay factor associated with manufacturing lead times.

    Unless inventory stockpiles are maintained with which to buffer against this, supply shortages (both at the input, and the finished goods level may well result). Component shortages will not, however, fuel inflation to the same extent as will shortages of finished goods inventory.
 
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