Inflation will inevitably rise sharply in coming months as the Russian invasion of Ukraine has added to the ongoing commodity price shock. Inflation may approach 8–9% across a number of the major economies, which is well above inflation targets.
Key factors:
- Supply imbalances continue with further supply restrictions in China and new ones hitting Europe due to the Russian conflict.
- Demand is staying strong, but there are some early signs of moderation.
- The large commodity price shock came from both energy and wider commodity prices.
- Food prices are rising due to supply disruptions.
- Energy security concerns will persist for much longer as supply chains from Russia remain under threat and there is a move to shift towards other energy sources.
- Tight labor markets and labor market shortages across a number of sectors indicate that wage growth may be on the rise.
Is there good news beyond 2022?
If the below factors begin to play out, both headline and core inflation should begin to ease by mid-2023 before moving towards target.
- Demand growth is beginning to ease at a gradual process. As real income contraction begins to bite in tandem with much lower savings and higher borrowing costs, the outlook is for excess demand conditions to ease.
- Slower demand should eventually lead to companies’ being less able to pass through higher prices to consumers.
- As labour market tightness eases and participation rates continue to rise (already seen in the US), the increase in labour supply will be critical in curtailing rising wage demands.
- A shift in consumer demand away from goods towards services eases the supply-demand imbalance.
Are there deeper long-term challenges that could lead to sustained higher inflation?
It is inevitable that a number of key changes will accelerate in coming months, quarters, and years that are likely to lead to a higher cost base:
- There are increasing signs that companies are attempting to move supply chains closer to home (i.e., where the production facilities are, and demand for these products is largely concentrated).
- Energy vulnerability is high up on the list right now, leading to one of the largest releases of strategic oil reserves by the US that will deplete their stockpile by almost 40%. Other countries are expected to follow suit to curb the current sharp rise in oil prices. Although this may benefit short-term, the reality is that these reserves will have to be re-built over time, keeping demand higher for longer.
- This is likely to lead to an acceleration in the shift towards alternative forms of energy supply away from oil and gas, but all of this requires longer-term planning and investment. In the interim, the global economy has to cope with higher inflation.
As difficult as these challenges may seem, we believe that central banks and governments must deal with the pandemic response first, as that will make it easier to map out a medium-term strategy.
