Tue, June 28, 2022


Global inflation and supply-chain shortcomings pose challenges to central banks

Consumer and wholesale prices are rising all over the world, for which there appears to be no quick fix, as many countries grapple with rising inflation and uneven economic recoveries.

Global inflation has risen due to a combination of supply disruptions, supply-demand mismatch, as well as a spike in commodity and energy costs.

The addition of geopolitical risks to this volatile mix threatens the fragile global recovery after two years of Covid lockdowns and a variety of measures introduced in most countries.

The Ukraine-Russia conflict further increases global uncertainty.  

Inflation and supply-chain disruptions
The central banks of most G20 countries are currently fighting inflation in one form or another.

Inflation in the United Kingdom hit 5.4 per cent in December, the highest in nearly 30 years. 

In January, the Bank of England became the first central bank among G7 nations to raise interest rates.

Canada’s consumer prices are rising twice as fast as before the pandemic, while in Japan – where prices have been depressed since the collapse of the real estate bubble over 30 years ago – the Bank of Japan has raised its assessment of inflation risks for the first time in eight years. 

China is the only major economy where inflation is lower now than before the pandemic.

Elsewhere, India is on track to be the world’s fastest-growing among large economies, while France is enjoying its strongest growth in 52 years. 

White House officials have said inflation would ease in the second half of this year, describing it as a side-effect of a robust recovery. 

Numerous economists have stated that Americans are seeing inflation surge faster than consumers elsewhere due to that country’s extensive financial rescue measures to fight the fallout from the pandemic.

Many central bankers and members of the Joe Biden administration attribute much of the surge in inflation to pandemic-related issues, including supply and transportation obstacles and labour shortages. 

The US Federal Reserve (the Fed) is targeting inflation at 3 per cent by the end of 2022 – which at this stage looks optimistic – with a longer-term goal of reducing it to 2 per cent as supply problems recede.
Citing the latest quarterly data, President Biden highlighted that the US economy was currently growing faster than China’s for the first time in over 20 years. He added that the US is “finally building an American economy for the 21st century”.  

The real proof of economic recovery would be apparent only when economic stimulus measures are fully withdrawn.

In North America, during the work-from-home era, spending habits shifted from theatres and restaurants to the purchase of durable goods, including computers, furniture, and vehicles. 

The prices of durable goods rose by 16.8 per cent over the past year.

Supply-chain bottlenecks
As factories around the world resume production in a post-pandemic revival, there is a clear mismatch between supply and demand, driving prices higher. 

Global supply chains and afflicted ports in Europe, China, Southeast Asia, and the US are driving costs up globally, a key factor in the rising inflation. 

The increasing costs of commodities, including food and energy, are piling on the inflationary pressure. 

WTI crude oil price is up by over 50 per cent in the past one year, while coffee has virtually doubled in price.

Supply disruptions could last into 2023, as the Omicron variant of the Covid virus poses fresh challenges, and Europe and China are imposing new restrictions. 

The International Monetary Fund reports that up to 40 per cent of supply constraints in manufacturing can be traced to pandemic-related shutdowns, which should have only temporary effects on inflation. This would also apply to severe weather and industrial accidents that slowed microchips and auto output in 2021. 

Labour shortages and ageing logistics infrastructure could, however, have more persistent effects on supply and inflation than shutdowns.

Supply shortages experienced by automobile manufacturers were largely expected to end by mid-2022. 

Supply constraints, however, are likely to persist in some key areas, posing a challenge for policymakers to facilitate recovery without inflationary pressures.

Potential policy solutions
Numerous policy and regulatory changes are required to deal with supply bottlenecks. They include: fast-tracking the licensing of transportation and logistics workers, temporarily easing restrictions related to operating hours at ports, streamlining customs inspections, easing immigration rules, as well as enhancing mandates that can contain the virus and protect the health of workers.

Fiscal measures could also be used to ease bottlenecks and increase output. 

Preserving skill-intensive manufacturing jobs will be viable once the bottlenecks ease. 

Additional measures to ensure recovery in labour supply include increasing care for children and the elderly, as well as training workers in new skills.

The prospect of prolonged supply bottlenecks poses challenges for monetary policymakers to sustain recoveries and ensure that output catches up with pre-pandemic numbers without allowing wages and prices to rise. 

Maintaining medium-term inflation expectations despite inflationary pressures from supply disruptions and increasing energy prices is key to managing this trade-off.

The G20 stance
The finance chiefs of G20 member nations have vowed to use "all available policy tools to address the impacts of the pandemic", while warning that future policy space was likely to be "narrower and uneven”.

"Central banks will act where necessary to ensure price stability, in line with their respective mandates, while remaining committed to clear communication of their policy stances," the ministers and governors said.

The G20 draft statement contained no direct reference to the crisis on the Ukraine-Russia border, saying only that the G20 would continue to monitor risks, including those arising from current geopolitical tensions. 

As Russia is a member of the G20, the communique was more general, using the word "current…tensions" to avoid Russian opposition.

It seems apparent that central bankers, whether through the G7, the G20 or other organisational structures, should continue to work cohesively and communicate how they will react to inflation and other related economic data, inflation expectations, and be ready to respond quickly to significant changes in the medium-term inflation outlook.

The greater the success of regulatory and targeted fiscal measures in alleviating current supply-chain bottlenecks, the lesser the need for policymakers to minimise aggregate demand and economic growth to rein in inflation.

All eyes on Fed
The US Congress approved a nearly $6-trillion stimulus package in March 2020 to keep the economy afloat. 

The recovery in US stocks, which commenced in March 2020 after a major sell-off five weeks before that, increased the aggregate US household net worth by nearly $28 trillion since the end of 2019.

Adjusted for inflation, the average disposable income of Americans actually rose during the pandemic.

The Fed is currently weighing a complex blend of global and domestic factors to effectively tackle 7 per cent inflation, the highest among G20 member nations.

Leading multinational investment banks anticipate a cycle of interest rate hikes in 2022, starting in March. 

In anticipation of these moves, all three major US stock indices are lower this year, with the Nasdaq sliding the most, down more than 10 per cent so far.

Higher-than-expected inflation is pressuring the Fed to tackle US consumer prices, which have risen at the fastest pace since the early 1980s.

The Fed communicates its policy decisions through its policymaking division, the Federal Open Market Committee (FOMC).

The FOMC meets eight times every year to discuss and release a detailed communique related to monetary policy decisions.
The next FOMC meeting on March 15-16 is one of the most eagerly awaited since 2008-09.

The funds’ target rate is one of the key monetary policy tools used by the Fed to facilitate economic growth.

This is the overnight rate at which commercial banks borrow and lend their reserves to each other.

The current Fed fund target rate is zero to 0.25 per cent.
Within the interbank, capital, and treasury markets, the general sentiment is that the Fed should move the rates up by 25 basis points (bps) at a time. Apart from times of extreme uncertainty, something markets despise, anything more than 25bps, such as the current talk of a potential 50bps hike, has many seasoned market participants believing that the Fed is “behind the curve”, or has been caught unprepared.

To the majority of the population that are not financial market participants, it may not seem relevant in their day-to-day lives.

However, as we have learned only too well since the Asian Financial Crisis of 1997, SARS in 2002-03, the Global Financial Crisis of 2008-09, and more recently the sell-off of global equities and their fallout in mid-February 2020, the world is highly interconnected.

Contagion is a very real risk that must be anticipated, hedged against, and responsibly managed by governments, central banks as well as global regulatory bodies in a cohesive and transparent manner.

Leading European and American global investment banks are anticipating rate hikes for 2022 in the range of 1.25 to 1.75 per cent.

The pace of the rate hikes, though, is as important as the extent of the hike. 

There is an increasing view of a 50bps hike in March, although this is not the majority view yet.

The additional hikes anticipated during the year at later FOMC meetings point to a consensus of a 25bps hike each time, totalling 1.25-1.75 per cent in total by the year-end.

Federal Reserve Bank of New York president John Williams recently told reporters that there was no reason for a "big” 50bps early move and that a steady move by the FOMC to get the Fed funds target rate up from zero to normal levels of between 2 to 2.5 per cent over the next few years or longer is the key objective.

This can be interpreted as an FOMC decision being “data-dependent”, leaving the door open for more aggressive and potentially bigger rate hikes.

St Louis Fed president James Bullard, who currently seems to be an outlier, recommends that the FOMC "front-load" its rate increases, as well as potentially hike rates outside traditionally scheduled FOMC meetings. These “sudden” hikes greatly increase volatility in global financial markets.
With the US economy riding an inflationary wave and increasing sentiment that the Fed is slow to react, the US central bank faces a dilemma.
Regardless of the extent and pace of rate hikes, the Fed will also offload massive stockpiles of bonds, as part of its pandemic stimulus efforts.

Inflation in ECB’s sights
Despite rapidly tightening labour markets in the eurozone, data suggests that wages will only rise moderately, and inflation is expected to fall slightly below the European Central Bank (ECB)’s target once the pandemic ebbs. 

The ECB’s current mindset is to adopt an accommodative monetary stance until its medium-term inflation target is met, while allowing flexibility to alter course if inflation data is higher than anticipated.

Prices are currently rising faster than at any other time since the eurozone was created in 1998.

European consumption remains depressed as many EU job-retention policies paid employers less than the full salaries.

The largest driver of inflation in the EU is energy prices, which is influenced by geopolitics, weather, gas stocks and reserves, insufficient investment in renewables and delayed maintenance of infrastructure projects.
The ECB is concentrating on anti-inflation measures by reducing its monthly asset purchases from the 2021 average of 82 billion euros to 20 billion euros in 2022.

Effects on Thailand
Despite higher inflationary risks and an increase in headline inflation in early 2022 due to higher energy and food prices, demand-side inflationary pressures remained subdued, in line with the gradual recovery of household income.

The Bank of Thailand (BOT) has said it remains committed to containing inflation within the target of 1 per cent, well below the current 3 per cent range, and anticipates headline inflation at 1.7 per cent in 2022. Inflation hit a high of 3.2 per cent in January, up sharply from 2.2 per cent in December 2021. The BOT is targeting inflation at 1.4 per cent in 2023, while focusing on minimising volatility in domestic markets. 

Thailand’s gross domestic product is still expected to grow between 3.5 and 4.5 per cent in 2022, as the tourism sector slowly recovers. The quarantine waiver for foreign tourists is expected to draw more international travellers. 

Fortunately, exports should continue to gain momentum despite global supply-chain disruptions.

There is also a hike in government spending on infrastructure projects, in addition to public-private investment projects. 
The BOT’s Monetary Policy Committee has vowed to continue with its current accommodative monetary policy for economic growth and intends to maintain the policy rate at 0.5 per cent. The current financial and fiscal measures focused on rebuilding and enhancing potential growth play a key role in bolstering the labour market recovery as well as household and business income.

An analysis by Terrence Bradley

Published : February 28, 2022


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