Eyes on the supply-side: Disruptions could lead to further price increases

The Covid-induced global lockdowns in 2020 ignited supply chain disruptions, which, in turn, paved the way for a great loss of global demand. Consequently, oil prices plummeted significantly to levels last seen in 2002, and indices of Commodity Research Bureau (CRB), Baltic Dry, London Metal Exchange and S&P GSCI tumbled to multi-year lows.

This plunge in commodity prices then trickled down to consumer prices, leading to the global consumer price inflation declining by 1% between January 2020 and May 2020. The impact was more prominent in advanced economies (AEs) than in emerging market (EMs) and developing economies (DEs). While the consumer price inflation in the US declined by nearly 240 basis points (bps) during this period, the decline in inflation for EMs like India, Indonesia, South Korea, the Philippines and Mexico remained relatively limited, thanks to supply disruptions offsetting some of the disinflationary pressures.

Since May 2020, commodity prices and inflation in many countries have been marching upwards. Even as a part of the spike was on expected lines as economies recovered from the worst of the Covid-19 pandemic, its magnitude has been larger than expected, possibly reflecting a consequence of demand-supply mismatches and base effects.

A sharp rebound in global demand as indicated by the surging new orders, accompanied by a relatively slower normalisation of supply chains as evident from the lengthened supplier delivery times reported by firms in business surveys, has sent input prices soaring to new highs. Global demand rebound has been mainly on account of swift reopening and robust vaccination drives and large stimulus measures announced by countries across the globe. Supply chain bottlenecks, on the other hand, have persisted, leading to a surge in freight and logistics costs and delayed shipments.

Rising input cost pressures have now seeped into global consumer prices, driving inflation, and posing challenges for the central banks. India, for instance, saw the worst recession last year among major countries, even as consumer price index (CPI) inflation remained higher than mandated levels.

Recessions usually set off a decline in global inflation that last several quarters beyond the trough of the recession and well into the recovery. Compared with previous episodes of recessions since the 1950s in the US and the inflation trajectory around them, the decline in inflation during 2020 was the most muted and least protracted. In most AEs, EMs and DEs, inflation has picked up since last year in line with the rise in oil and other commodity prices. Shipping cost rates have soared in recent months due to the conjunction of booming demand for consumer durables from Asia and supply-side bottlenecks created by sanitary restrictions in ports and terminals.

Among the drivers of inflation data compiled by the OECD for most AEs, surging prices in the transport segment, as well as increase in prices of housing, utilities and other fuel segments, have contributed the most to the recent inflation prints. However, for EMs and DEs, a significant jump in food prices amid shortages, alongside the surge in global food inflation, has been the top-most contributor to higher inflation prints. Surging commodity prices, weaker currencies, increase in indirect taxes and regulated electricity prices in a few EMs have also added to price pressures.

In India, a surge in global commodities combined with domestic supply-side constraints weigh on the core basket. Partial relief from easing food inflation has allowed the Reserve Bank of India (RBI) to stick to its accommodative stance to support growth. That said, sequential hardening of inflation for the seventh month in a row in August, along with hardening expectations as seen in the latest RBI survey, calls for some caution over the trajectory going forward. This shows that the heterogeneity in policy actions seen across the globe is equally due to underlying macro configurations, apart from just inflationary pressures.

Notwithstanding a higher-than-expected spike in US inflation this year, benchmark bond yields there have moderated, possibly indicating increasing concerns about a potential peaking of US economic growth. Expectations of a sequential moderation of the US economy in the second half of this year are gaining strength, a point highlighted in recent Federal Open Market Committee (FOMC) commentary.

Such moderation could turn more noticeable in the first half of 2022 as fiscal support fades. This is evident from moderating indicators like the US weekly Economic Cycle Research Institute (ECRI) leading index, Citi’s Economic Surprise Index and Germany’s ZEW (Centre for European Economic Research) indicator of economic sentiment.

Current inflationary trends should be transient. But there are lingering upside risks that can keep them elevated for longer than expected, including a persistent pick-up from current levels. Intensifying supply-side disruptions, especially related to global supply chains, could lead to further price increases.

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