Globally and domestically very high inflation has prompted central banks around the world to raise interest rates, typically quite rapidly, which has dulled confidence measures, whether those of investors, businesses or households. The focus is squarely on inflation and on the increased financial hardship often experienced from higher interest rates — in particular rapidly higher rates.
The bad news is that inflation is not expected to fall quickly in the rest of 2022 and regain the targets central banks wish inflation to run at. So higher interest rates are likely. The good news is that international commodity prices have been falling, though not all of them are below where they were a year ago, with price inflation measured for the latest set of prices by comparing them with the previous period, whether that is a month or year ago.
In terms of international commodity prices, metal prices are typically lower than they were a year ago and a month ago, as are the prices of industrial commodities. However, the prices of agricultural goods are not, both food and nonfood (such as cotton, wool and wood). Food and energy prices have been key movers of inflation in 2022, with energy prices in particular lower month on month or a few months ago, but still not on a year ago.
This is key for inflation. Petrol prices, which are up more than 40% year on year, still exert considerable support to high inflation (measured year on year), preventing a rapid drop. And it is the year-on-year measure of inflation that is typically targeted by central banks.
Supply chains are still under pressure, which has added to producer costs. And production costs typically affect prices faced by consumers for goods and services. Global supply chains, which feed components into the production of goods just as much as they deliver finished products, have been under pressure since the Covid-induced lockdowns of economic activity and have not resumed their previously seamless operations, particularly for the production of complicated goods.
A delay in the production of just one component of, for example, a car, which typically has its components produced all over the world, results in the delay of the finished overall good. The global supply chain turns raw materials, or commodities, into finished goods, with these raw materials coming from different regions globally, and finished goods — such as chips — typically then going into a range of electronic devices.
Global supply chains are deep, complicated systems, and interrupting them or bringing them to a complete halt — as the government-imposed global lockdown restrictions did — caused a serious dislocation of a smooth, functioning system, which is still unsurprisingly being felt in high prices.
Shortages of a particular good (or service) in the face of high demand for it, even if the shortage is temporary, pushes up prices, in turn driving up inflation.
Central banks hike interest rates to reduce the amount of income consumers have to spend on goods and services, and so reduce the demand for these goods and services.
But a severe reduction in the consumption some goods (and services) is not feasible, such as food, heating (in particularly cold climates) and fuel used for transport. Some reductions can be made, and this is what central banks are driving at, particularly excessive consumption and spending on non-necessities such as luxuries.
Central banks become particularly concerned when high inflation urges workers to demand, and achieve, higher wage increases, in line with or exceeding the high inflation rate, thereby embedding the high prices and inflation rates in the system. This is known as a wage price spiral.
Central banks are consequently seeking material evidence of falling demand-led inflation, as opposed to the supply-side inflation driven by high commodities prices, production costs and so overall supply chain costs. Covid-19 restrictions meant borders were closed and transport systems for goods were largely shut down, as were factories, retailers and indeed economies overall, bar critical goods production.
Even as lockdown restrictions were eased, production could not be rapidly restarted as different countries saw levels of restrictions fluctuating , while consumers increased demand for goods they had previously been denied. That placed severe upward pressure on demand and thus production, causing supply chain backlogs and bottlenecks. The Russia-Ukraine war has further affected global supply chains and stretched out the high global inflation period.
The problem, however, is that central banks have typically waited too long to hike interest rates and are finding it more difficult to push inflationary pressures down, resulting in a large and rapid series of hikes. This is likely to continue as central banks are now determined to get inflation rates back to their targets, but are unlikely to achieve them in 2022.
• Bishop is Investec chief economist.
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