Inflation still poses questions

This week is the unhappy first anniversary of Russia’s unexpected unprovoked invasion of Ukraine. Global energy markets were shocked, sending oil, gas and coal prices spiking higher.

Food prices also jumped, as Ukraine’s famed black soils makes it one of the world’s breadbaskets.

This gave the global inflation surge already underway renewed impetus. Prices were already rapidly rising over a broad front largely due to pandemic-related supply disruptions and the sudden and unexpected shift in consumer spending from face-to-face services to use-at-home goods. Consumer spending in developed countries also benefited from government stimulus.

While the war sadly continues, energy prices have stabilised at pre-invasion levels. Putin’s attempt to use gas as an economic weapon against the West has failed, but the West’s attempts to curtail Russian oil exports have not been entirely successful either. Russia has found new customers in India and China, just as Europe found new sources of gas supplies. Agricultural prices are similarly back to earth, though it will take time for this to filter through to retail food prices.

The disruptions caused by the pandemic are also fading. Logistical logjams have eased, transport prices have normalised, and production is running smoothly. In fact, acute shortages have in many instances given way to surpluses. Microchips are the poster child for this tomato sauce bottle effect when at first nothing comes out, and then, after shaking the bottle, everything comes out at once. Hence the global manufacturing sector is experiencing a downturn as inventories rise and production is scaled back, putting downward pressure on manufactured goods prices.

The declines in goods and commodity prices means that headline inflation rates are falling from four decade-highs in developed countries and multi-year highs in developing countries such as South Africa. So far, so good.

Making waves
However, this does not mean the inflation dragon has been slayed. Service inflation in the developed world remains high and is rising in many cases. This reflects the fact that consumer spending is shifting back to services – people only need so many exercise bikes, additional computer screens and coffee machines – but also that labour is scarce across these countries. Services are more labour-intensive. You can put robots in a factory but not in a restaurant, hair salon or pharmacy, not yet anyway.

Chart 1 illustrates these three waves using the US as an example. First the increase in “core” goods inflation (goods excluding food and energy), then the further jump in food and energy inflation following the invasion. But now that goods and commodities are declining, service inflation remains high.

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