Inflation: it’s back and this time it means business.
At first it seemed impossible to comprehend how this could even be possible with collapsing global demand during the pandemic. Then, it was dismissed as a transitory phenomenon due to constrained supply chains. Now, not only has it set in for the duration but it is becoming prevalent across the world. How did this happen?
First of all, to understand how prevalent it has become we need to look at the numbers: According to the IMF’s World Economic Outlook there has been a jump in the number of countries facing inflation over 5% in the full year ending December 2021. Amongst the Advanced Economies (AE) 15 out of 34 countries saw inflation prints above 5% last year; this number hasn’t been seen in 20 years. Of the Emerging Markets/ Developing Economies group (EM/DE) 78 out of 109 countries faced inflation over 5% which is twice the number seen at the end of 2020. AT the moment only Asia as a whole seems to have escaped this. But even India just saw a January print above its 2-6% comfort zone for inflation.
Fig.1: Inflation spreading globally
Source: IMF, World economic Outlook
The reasons are different but the spread is unmistakable. Whilst the AE’s problem partly can be attributed to monetary and fiscal stimulus- an overheating economy problem, that isn’t the case in the EM/DE basket which did not have the luxury of being able to spend their way out of the recession/ compression brought about by the pandemic. Which is why 41% of the AEs have recovered (ie. where their GDP at the end of 2021 is equal to or greater than at the end of 2019) whereas only 28% of the middle-income EM/DEs and 23% of the low-income EM/Des have managed to achieve that benchmark.
What they have faced in common with the rest of the developed world is the rapid increase in commodity prices, the overall rise in global demand, supply chain constraints and the rise in food prices. The supply chain crisis has morphed from one where logistical issues (barriers, labour shortages and backlogs at ports due to the pandemic) to one where shipping companies are reporting record prices thanks to the greatly elevated transport costs (profiteering). We look at this a little lower.
Also in common are oil prices; these are high and expected to climb higher. Already up from USD 70 at the end of 2021 it’s threatening to break above USD 100 within the first two months. Oil has climber 77% from the end of December 2020. This is bad news for the global recovery and very bad news for inflation. We are already at levels not seen since 2014 and the prognosis is not great at the current moment unless you’re in an oil producing nation. The reason for the price rise is as much geopolitical as the surge in demand as countries come out of lockdown but the effect felt is uneven across the board. The potential conflict between Russia and the Ukraine (as of today 15th February it is still a potential conflict) is only the icing on the cake. OPEC+ has been slow to rush back into production as they do enjoy the fruits of higher prices for their oil. Russia itself is expected to rake in USD 65 billion more in revenue this year if oil prices remain at current levels. It would appear that Russia can afford to play the long hostile game since Europe is also dependent upon Russian gas (a third of pan-European gas supplies come from Russia) and gas prices have been a particular pain point for the EU and the UK.
Rising commodity prices do help some of the middle income EMs like the Latin American economies in terms of keeping their income buoyant but this is offset by the effect of rising food prices globally. So, though the rich benefit from owning the assets that give rising income streams, the poor are facing difficulties in buying food- a major component of their spending. In 86 out of the 109 EM/DEs surveyed (79%) food price inflation exceeded 5% last year. This contrasted with only 27% of the AEs. This will lead to widening income gaps between the rich and poor nations- not a positive outcome. The IMF has raised its forecast for consumer price rises to 3.9% (up from 2.3%) for AEs and 5.9% for EM/DEs- evidence that there will be a corrosive effect of inflation that will widen the rift between the wealthy and the not so wealthy.
Rising commodity prices will also feed through into industrial production costs- particularly, copper and iron price rises. Copper is an essential and ubiquitous component in all electronic goods (and basic electric wiring for that matter) and we could expect to see price rises in finished goods sooner rather than later. Many companies in the US are already increasing prices under cover of inflation (despite record profits declared for last year). Natural gas, commodity and oil price rises are going to impact global growth down the line. They raise costs of living when not directly impacting production costs. Fossil fuels make up 80% of the global economy energy costs and this basket is already up 50% in cost. Bank studies have estimated a 0.2% haircut in global growth with every $10 increase in oil price for example (it’s lower for the US- at 0.1% thanks to low cost fracking).
The response of the central banks- and as I’ve said often, the US Federal Reserve in particular, will play an outsized role in determining the duration and magnitude of inflation globally. A poll of economists by Reuters expects the Bank of England to raise rates faster than previously believed. The BoE are busy blaming elevated energy prices as the reason their hand is being forced; so is the ECB. Goldman Sachs now expects the Federal Reserve to raise rates 7 times this year alone as the priorities change for the central banks to change from managing consumer demand and employment targets to price control. There is a fear that they are already behind the curve and unused to the current state of affairs. This could lead to a situation where they will have to act in a drastic manner once the damage is already done. We need to hope that they act sooner and bolder than that.