Inflation in the G7 group of countries climbed to 7% year-on-year (y/y) in March. This is the highest rate recorded in almost four decades. Headline rates of inflation are above central banks’ targets in virtually every major developed and emerging market economy.
Chart: G7 inflation climbed to a multi-decade high in March
The peak in global inflation is probably not far away. For some countries, it’s likely to already be in the rear view mirror, such as the US.
Although headline rates of inflation may soon begin to decline, concerns remain that they will do so relatively slowly for at least three reasons.
First, the continued zero-Covid policy in China means that supply chain bottlenecks are likely to persist for some time. The imposition of lockdowns hit China’s economy in April and economic output (GDP) is likely to contract in the second quarter compared to the previous quarter.
While the lockdowns have hit the domestic economy, they are likely to have far-reaching consequences for the rest of the world.
After all, China has become central to global supply chains and the restrictions put in place to contain Covid have hampered manufacturing activity and caused a logjam in transport infrastructure.
There has been signs that supplier delivery times will lengthen and there is a risk that supply chains will deteriorate.
Energy prices have stabilised since the initial shock to markets that followed the invasion of Ukraine by Russia. But they remain high and could go higher again.
Russia has cut off the supply of gas to Poland and Bulgaria and the threat to stop supplying other, larger European countries remains. At the same time, the EU is trying to reach an agreement on a new round of sanctions that would include an embargo on Russian energy, potentially as soon as the end of 2022.
However, it is perhaps food prices that are the greatest threat. According to the UN’s FAO index, food prices have already climbed by about 20% so far this year in nominal, US-dollar terms. And the huge price shock in the fertiliser market means there is a risk that higher food costs persist. After all, Russia and Belarus have historically been important sources of fertiliser for the global economy. The long production cycle in agriculture means that these higher input costs could keep prices elevated for some time.
Meanwhile, climate change is also affecting crop production in some key markets such as India. This is a particular threat to the emerging markets, where food accounts for a relatively large proportion of CPI baskets and past spikes in prices have provided the spark for social unrest, such as the Arab Spring in 2010.
A third concern for the inflation outlook comes from the services sector. This is an area that is only just revving up as fading concerns about Covid have seen demand start to rebalance back from the consumption of manufactured goods.
Incoming data from the UK, which was the first major economy to abandon Covid restrictions, have shown a clear shift in demand back towards services. In the US, service sector output is only just returning to pre-pandemic levels and is likely to climb further as demand returns.
A resurgence in service sector demand is likely to require more workers at a time when unemployment is already very low and wages are rising. Service sector activity tends to be labour intensive and therefore output prices are particularly sensitive to wage costs. This raises the risk that services could soon take over as the key driver of inflation to add to fears of a wage-price spiral.
Considering all of these risks, we have revised up our forecast for global inflation this year to 6.4% from 4.8% previously. Although we still expect inflation to decline next year, it will probably do so more slowly and we have revised up our forecast to 3.6% in 2023 from 2.8% previously.
The contents of this document may not be reproduced or distributed in any manner without prior permission.
This document is intended to be for information purposes only and it is not intended as promotional material in any respect nor is it to be construed as any solicitation and offering to buy or sell any investment products. The views and opinions contained herein are those of the author(s), and do not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The material is not intended to provide, and should not be relied on for investment advice or recommendation. Any security(ies) mentioned above is for illustrative purpose only, not a recommendation to invest or divest. Opinions stated are valid as of the date of this document and are subject to change without notice. Information herein and information from third party are believed to be reliable, but Schroder Investment Management (Hong Kong) Limited does not warrant its completeness or accuracy.
Investment involves risks. Past performance and any forecasts are not necessarily a guide to future or likely performance. You should remember that the value of investments can go down as well as up and is not guaranteed. You may not get back the full amount invested. Derivatives carry a high degree of risk. Exchange rate changes may cause the value of the overseas investments to rise or fall. If investment returns are not denominated in HKD/USD, US/HK dollar-based investors are exposed to exchange rate fluctuations. Please refer to the relevant offering document including the risk factors for further details.
This material has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.