3 Reasons Why Inflation Isn’t Going Away Any Time Soon By Investing.com



Investing.com – The latest known inflation data is setting off alarm bells for central banks and consumers alike. Indeed, inflation in the G7 group of countries is at its highest level in nearly four decades, running above central bank targets in virtually all major developed and emerging economies.

In this scenario, in Schroeders (LON:) look at up to 3 reasons why inflation isn’t going to go away any time soon, while raising their forecast for global inflation this year to 6.4%.

Below, David Rees, senior emerging markets economist at Schroders, details these reasons.

How did we get here?

The roots of the current outbreak of global inflation go back to the start of the Covid-19 pandemic, when there was a large imbalance between the supply and demand for goods.

The global economy contracted sharply in the first half of 2020 as lockdowns were imposed, but what followed was a rare downturn as most households sheltered from the economic shock. Many were able to continue working from home on full pay, while the finances of many other households were protected by government schemes, with the result that overall net savings increased considerably.

With consumers flush with cash and most of the world economy shut down, especially the services sector, pent-up demand turned to the goods sector. For example, US retail sales increased 20% in just one year and continue to rise as the economic recovery accelerates.

Even in normal economic times, the supply of goods would have a hard time keeping up with such a large increase in demand.

Tensions in production were exacerbated by the Covid closures and the disruption of transport channels. The shortage of products caused the deterioration of the delivery times of the suppliers and the imbalance between supply and demand translated into an increase in prices.

More recently, the fallout from the tragic events in Ukraine has exacerbated these underlying inflationary trends, as commodity prices have soared. This has added fuel to the fire and pushed inflation even higher.

Three reasons why inflation is likely to keep rising for longer

The peak of global inflation is likely not far away. For some countries it may already be in the rear view mirror, such as in the United States.

Although headline inflation rates could start to decline soon, there are still concerns that they will do so relatively slowly for at least three reasons.

Reason 1: The impact of China’s zero-Covid policy on supply chains

First, the continuation of the zero-Covid policy in China means that supply chain bottlenecks are likely to persist for some time. The imposition of lockdowns hit the Chinese economy hard in April and economic output (GDP) is likely to contract in the second quarter compared to the previous one.

And while the lockdowns have hit the domestic economy hard, they are likely to have far-reaching consequences for the rest of the world.

After all, China has become a central element of global supply chains, and the restrictions imposed to contain Covid have severely hampered manufacturing activity and caused a bottleneck in transport infrastructure. For example, a daily data set on container ship congestion in China’s 55 major ports has increased as ships have been forced to wait to be loaded and unloaded.

This has historically been a sign that supplier lead times will lengthen and there is a risk that supply chains will deteriorate markedly again.

Reason 2: The prices of raw materials

Energy prices have stabilized since the initial shock to markets following Russia’s invasion of Ukraine. But they are still high and could go back up.

Russia has cut gas supplies to Poland and Bulgaria and continues to threaten to stop supplying other larger European countries. At the same time, the EU is trying to agree on a new round of sanctions that would include an embargo on Russian energy, potentially as early as the end of 2022.

However, perhaps it is food prices that are the biggest threat. According to the United Nations’ FAO index, food prices have already risen about 20% so far this year in nominal terms, in US dollars. And the huge price shock in the fertilizer market means there is a risk that higher food prices will persist. After all, Russia and Belarus have historically been important sources of fertilizer for the world economy. The long production cycle in agriculture means that these higher input costs could keep prices high for some time.

Meanwhile, climate change is also affecting crop production in some key markets like India. This is a particular threat to emerging markets, where food makes up a relatively large share of CPI baskets and past price spikes have sparked social unrest such as the 2010 Arab Spring.

Reason 3: revival of the services sector

A third concern for the inflation outlook comes from the services sector. It is a sector that is barely reactivating, since the fading of concerns about Covid has caused demand to begin to rebalance from the consumption of manufactured products.

Data from the UK, which was the first major economy to abandon Covid restrictions, has shown a clear shift in demand towards services. And in the US services sector, production is only just returning to pre-pandemic levels and is likely to rise further as demand recovers.

The revival of demand in the service sector will likely require more workers at a time when unemployment is already very low and wages are rising. Service sector activity tends to be labor intensive and therefore producer prices are particularly sensitive to wage costs. This raises the risk that services will soon become the main driver of inflation, adding to fears of a wage price spiral.

Forecasts

“Taking all of these risks into account, we have revised our global inflation forecast for this year upwards to 6.4% from 4.8% previously. While we continue to expect inflation to ease next year, it probably will.” more slowly and have revised our forecast upwards to 3.6% in 2023 from 2.8% previously,” said David Rees.

Within this, much of the upward revision is coming from developed markets. Incoming data suggests that US inflation peaked at 8.6% in March. Schroders expects the trend to be down in the coming months, but only to return to the Fed’s 2% target in the fourth quarter of 2023.

“We expect the peak of inflation in the UK and in the euro zone to come a little later, in the second and third quarters respectively. However, while we think that inflation in the euro zone will fall back below At 2% in the second half of next year, we expect UK inflation to remain above target through 2023,” Rees concludes.

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