Why are we seeing high inflation? There are a lot of moving parts here, so let’s break it down.
The pandemic and cost of living
Inflation levels rose significantly towards the close of 2021, where the UK recorded its highest rate of inflation in almost 3 decades, at 5.4%, and the US experienced its highest inflation rate in nearly 40 years, at nearly 7%. The rising cost of living was largely associated with significant energy cost hikes and wide-spread supply chain disruptions.
The pandemic suppressed global demand and consumption for energy, therefore driving fuel prices to their lowest levels in decades. As the global economy recovered quickly the demand for fuel also rebounded, however suppliers were unable to satisfy the market demand and consequently the price of fuel rose dramatically. Increased demand for gas and electricity is derived from numerous factors, such as rising demand for central heating over winter and fueling cars to return to work. Demand-side pressures have significant upward effects on inflation if supply is trailing, exemplified by US petrol prices jumping 6.1% towards the end of 2021 as people became more active after the pandemic.
Supply chains and staffing shortages
Supply chain disruptions were a common theme throughout the pandemic, with food supply heavily affected; disruptions worsened with the emergence of new COVID-19 variants, such as Omnicron. The implications were widespread affecting markets worldwide, compounded by globalisation and the levels of interconnectivity. CPI rose 0.5% in the UK between November and December ‘21, with food and drink the largest contributors to the increase. The pandemic caused staffing shortages across all sections of the food supply chain, whilst increases to fuel prices impacted transport and production costs. Consequently, there were food supply shortages and increased prices for consumers after these effects were accounted for, demonstrating how knock-on effects from the pandemic influenced the food supply chain via multiple channels, and ultimately the levels of inflation.
What has the government’s response been?
In order to address the trend of rising inflation both the Bank of England and the Federal Reserve implemented contractionary monetary policy, raising interest rates by 0.25% in February ‘22 and 0.25% in March ‘22, respectively. As a result, bank savings earn more interest, the cost of borrowing for consumers increases whilst repayments on outstanding loans are more expensive, leading to lower levels of consumer spending and investment. Likewise, for some countries the UK may become more attractive to relocate capital to depending on their relative interest rate, hence strengthening the value of the pound and reducing net exports to quell inflationary pressures.
Contractionary monetary policy could not account for the impact of a full-scale invasion of Ukraine on 24th February 2022 by Russia; this further impacted global geo-political stability and any associated markets, leading to various trickle down effects and repercussions.
Supply chain issues and food shortages, contributing to high inflation, have worsened due to the conflict. For example, both Russia and Ukraine jointly account for more than 25% of global trade in wheat, and approximately 20% of corn sales, but much of the supply is on hold. Wheat and corn are two of the most produced crops globally, processed for human consumption and feed for livestock. Halting such a significant concentration of global supply has caused mass disruption in food supply chains – the price of wheat is up 45% in the first three months of the year, compared to last. This is reflected in other food markets which increases the costs of food production, hence the aggregate price of food is also rising.
Let’s not forget commodities…
Moreover, oil and gas are commodities in which Russia holds considerable influence as one of the largest producers in the world. They have significant stocks of natural resources, facilitating the production of 12% of the global economy’s oil and 17% of its natural gas. The war has huge influences on the energy market, intensified in the Eurozone where the bloc imported 40% of its natural gas from Russia.The reliance on Russian gas and oil has caused nations to begin deviating due to the severity of potential supply shocks. A quarter of Russian energy has been disrupted, largely due to sanctioning by European buyers or government sanctions in North America. Therefore, with finite supplies demand for oil elsewhere has increased, raising the price per barrel. This has led to mass inflation of derived goods such as petrol, where UK drivers are facing record prices at the pump of 188.7p per litre, further propelling the cost of living crisis.
A post-Brexit UK is also starting to demonstrate a rising cost of living. With significant numbers of labour shortages and job openings, there is upward pressure on wages as the demand for labour and the bargaining power of workers increase. This translates to higher prices for consumers once businesses account for the additional variable costs.
Dramatic energy price rises, food shortages and supply-chain issues resulting from the pandemic are all significant factors as to why inflation is currently so high. However, these factors have been largely exacerbated by the conflict in Ukraine, which appears likely to continue throughout the year, where in any case, consumer prices and inflation will continue to be impacted.
Nothing lasts forever
Nonetheless, the current economic outlook is not everlasting and a recovery will ensue assuming the war is contained. In the EU a slowdown in growth is expected, however inflation is projected to increase from 2.9% (2021) to 6.8% (2022), and then fall back to 3.2% in 2023. This indicates the bloc is expecting a return to inflation slightly above targeted baseline levels, with all things equal. The US mirrors this forecast, where CPI (consumer price index) is predicted to rise to an annual inflation rate 8.3% for 2022, and fall to 3.1% in 2023. Likewise, the Bank of England is predicting inflation increases until the end of this year, though they expect a significant slowing in 2023 and a return to the 2% baseline by 2024.
Countries are responding accordingly by implementing contractionary monetary policy to quell upward pressures, whilst the main drivers of inflation will not persist forever. 2022 will see continued hardship for people regarding this issue, as well as debate on how to best deal with it, however 2023 onwards will likely produce significant recoveries for many nations!
This information is for educational purposes only and does not constitute advice nor a recommendation. You should consider your own personal circumstances when making investment decisions. If you are unsure how to proceed, you should seek professional independent advice as to the suitability/appropriateness of any investment for your individual circumstances or needs.