What’s driving global inflation?
Following the COVID-19 pandemic, prices rose because of central banks’ expansive fiscal and monetary support, pent-up consumer demand, supply chain disruptions and increasing commodity prices. The invasion of Ukraine by Russia then exacerbated these effects, resulting in higher energy and food prices.
Initially, inflation expectations were moderate, but recently we have seen increased expectations of ongoing future inflation. In the United States, for example, sharply rising housing prices and prolonged input supply shortages have kept inflation rates higher for longer.
Another factor is that as economies recovered from COVID-19, the demand for labour quickly outstripped supply. The reduced labour supply was due to a range of unique factors including changes in work-life balance, hesitancy to return to work because of ongoing health concerns, difficulties in finding child and family care and issues relating to social distancing and lockdown restrictions. The overall effect was a tightening of labour markets, which has put extra upward pressure on wages.
Higher pay = more money to spend – but also creates higher-priced goods
And this is what causes the spiral effect: rising inflation expectations and tighter labour markets push workers to persistently demand wage increases to catch up to or exceed the recent rise in inflation.
In October 2022, the International Monetary Fund (IMF) warned that sustained higher inflation may feed into wages, leading to a wage price spiral and in turn prolonging the fight against inflation.
The IMF suggests that anchoring inflation expectations is key to obtaining and maintaining a low inflation rate. This is why many countries (South Africa included) make use of an inflation target to guide monetary policy and anchor inflation expectations.
How are central banks likely to respond to rising inflation rates?
Anchoring inflation expectations requires even stronger monetary policy responses. This means that central banks will need to remain aggressive in hiking interest rates and this may push economies into recession.
Consequently, the chances of an outright recession occurring in the United States or even the world economy during 2023 has risen appreciably. It is also unlikely that there will be any meaningful recovery in financial markets until the major central banks can demonstrate that inflation is under control and interest rates have peaked.
On the positive side, a clear indication that interest rates are helping to control inflation will provide significant relief to financial markets.
Walking the tightrope
It’s clear that the task of central banks is not an easy one: finding the appropriate amount of monetary policy tightening to dampen wage demand and anchor inflation expectations, but at the same time avoid pushing the major economies into a severe recession.
What are your options?
Speak to your CERTIFIED FINANCIAL PLANNER® professional to get into the details of what changes you need to make to your investment portfolio to take into account current global economic conditions with respect to meeting your long-term investment planning goals.
By Morné Bezuidenhout, CFP®
B.Com LLB
