Inflation is still a threat to the economy

The bad news on inflation is not over yet. In fact, it is still far from over. With the unexpected rise of inflation at 7.6 per cent year on year last month, the banking authorities are not having a good night's sleep. This May inflation rate represents a 10-year high.

The market consensus for May inflation was only 6.5 per cent. This warranted the central bank's move to tighten monetary policy by raising interest rates. Their next meeting will be on July 16. The most likely possibility is that they will raise the rate by 25 basis points to curb the runaway inflation, fuelled by the surge in energy prices.

Why does the Bank of Thailand need to raise rates when the economic growth forecast has already been downgraded?

If you look at the core inflation rate in May, you will see that it stood at 2.8 per cent. The central bank is mandated to maintain core inflation (which excludes food and energy weightings) at 0 to 3.50 per cent. Core inflation is rising fast enough to test the high end. If it were to breach 3.0 per cent - as it certainly will if inflation peaks in the third quarter - it will be extremely difficult to bring it down.

Rising inflation must be nipped in the bud before it gets out of control. A German central banker used to say that allowing inflation to get out of control was like pressing the toothpaste out of the tube and that it will be very difficult if not almost impossible to get it back into the tube.

Inflation hurts ordinary people the most. To avoid possible social unrest, the authorities must focus on managing price stability rather than concentrating on economic growth.

Some believe that inflation in June will continue to climb, reaching 8.3 per cent as the price of oil surged above US$130 (Bt4,310) a barrel. If the oil price rises even higher, Thailand's inflation rate will spike more than 9 per cent.

SCB Securities has estimated that energy price inflation, which accounts for 14 per cent of the consumption basket, will peak in August and contribute more than 3 percentage points to headline inflation. This would mean that overall inflation would reach a high of 8.5 per cent or higher.

Still, SCB Securities does not expect to see an aggressive round of rate hikes from the banking authorities as the Finance Ministry still would like to stimulate economic growth, which is expected to reach 5 per cent. The brokerage expects the central bank's policy rate to remain at 3.75 per cent until year-end.

Another key reason that warrants monetary tightening is the deteriorating trade and current accounts.

In April, Thailand recorded a trade deficit of $1.77 billion and a current account deficit of $1.64 billion, although oil imports contributed largely to the deficit.

A rate adjustment at this time might not tame inflation from pass-through costs, but it does, as Citigroup argues in its latest research: "reposition short-term market rates to a level consistent with an elevated inflation risk that may encourage savings and discourage spending on durable goods". It believes that the tightening cycle may comprise a series of quarter-point rate hikes totalling 50 to 75 basis points spread over the second half of 2008.

Monetary tightening would also result in a stronger currency. A stronger baht would help curb inflation, although it will hurt exports. So far Thailand and other countries in the region have been attempting to maintain a competitive currency level to boost exports.

But a policy shift is necessary this time in the wake of rising inflation to levels unseen since the last oil crisis. The World Bank has been issuing warnings about second-round inflation effects - or rising prices for goods and wages across the board. This would pose a serious threat.

If you earn less than 8-9 per cent this year compared to last year's earnings, you will be worse off.

Looking around, not many businesses, particularly small-and medium-scale enterprises, are going to post earnings growth of more than 9 per cent. Indeed, they are happy if they can break even.

With high inflation, consumers will be cautious about spending. Businesses can't pass on their higher costs to consumers because demand would be weak. Their margins would be badly squeezed.

There is no easy answer for us in this high inflation period but simply to bite the bullet.