What’s next for global inflation?

The rise in inflation from mid-2021 had three main causes:

• Global supply chain disruptions due to the Covid-19 pandemic.
• Exceptional monetary and fiscal policies to support the economy during the pandemic.
• The shock to commodity prices following Russia's invasion of Ukraine.

Global supply chains were disrupted by the Covid-19 pandemic, leading to a nine-fold increase in global freight rates and increasing imported goods prices (see Chart 1). Having peaked between late 2021 and mid-2022, freight rates fell quickly following the normalisation of labour markets after a pivot away from anti-Covid policies and the expansion of shipping fleets. On some routes, shipping costs have fallen below levels witnessed in 2019. This will exert downward pressure on durable goods prices, whose inflation rate is converging towards the barely positive level that prevailed before the onset of the pandemic.

Chart 1. Global freight rates (USD)

Source: LSEG Data & Analytics. Data as of 27 October 2023.

Inflation was also boosted by accommodative economic policies in recent years. Exceptional liquidity injections implemented by governments and central banks to support economies during the pandemic fuelled consumer demand just as supply chain bottlenecks emerged. When Covid-related mobility restrictions were lifted, surging demand for services coincided with labour shortages. Consequently, prices soared.

However, the policy mix has changed dramatically since late 2021. Central banks in emerging market economies were first to raise interest rates and were shortly followed by central banks in developed economies, resulting in an unprecedented tightening of global monetary policy. Fiscal policies have also become less accommodative. Changes in banks’ lending standards exacerbated the tightening of financing conditions and contributed to a contraction in real global money supply, pointing to an imminent slowdown in economic growth (see Chart 2). The rebalancing of supply and demand for goods and services has historically been accompanied by falling inflation. 
 

Chart 2. Global money supply and industrial output (year-on-year)

Source: LSEG Data & Analytics and EFGAM calculations. Data as of 27 October 2023.

The latest shock to price stability was caused by the outbreak of war in Ukraine following the Russian invasion. These countries are major global producers of grains and other agricultural products. Furthermore, Russia is a major exporter of a broad range of raw materials, including crude oil and refined petroleum products, natural gas, fertilisers, and metals. The reduced availability of these commodities due to sanctions imposed against Russia, and the uncertainty over agricultural goods supplies, boosted their prices.

However, higher prices motivated consuming countries to reduce demand and diversify their supply sources. Concurrently, other producers increased supply, attracted by higher prices and the possibility of acquiring market share to the detriment of Russia. Unsurprisingly, the prices of most commodities have returned close to the levels sustained before the war in Ukraine (see Chart 3). This will gradually pass through to consumer prices, having already lowered producer prices. 
 

Chart 3. Commodity prices (year-on-year)

Source: World Bank and EFGAM calculations. Data as of 27 October 2023.

Energy prices could be an outlier in this respect. The structural fall of Russian natural gas supply, OPEC+ policies to support oil prices, and renewed tensions in the Middle East all pose the threat of high and volatile energy prices. This represents the biggest risk to the inflation outlook, particularly in energy importing countries.

In conclusion, inflation is decreasing in major economies following volatility over the last three years. Structural and cyclical factors indicate that, in the absence of new adverse shocks, inflation will continue to converge towards central banks' objectives in the coming quarters.