The multiplicity of factors serving to build up inflationary pressures in the current market conditions is daunting. Inflationary expectations are on the rise and approaching multi-year levels in Russia and abroad, writes Valdai Club Programme Director Yaroslav Lissovolik.
As the world economy is coming to its senses after the blows of the pandemic, new risks and vulnerabilities are emerging in the aftermath of the unprecedented stimulus unleashed by both emerging and advanced economies. The key risk that is starting to unnerve financial markets and policymakers is the specter of higher inflation as reflected in the latest figures coming out of the US and emerging markets. Russia is having its fair share of inflationary pressures, which the CBR is likely to counter through further rate hikes. And while the dominant view in the markets is still that the pick-up in inflationary pressures is temporary, there is a rising concern that the risks of higher inflation have been underestimated, including by the monetary authorities.
The multiplicity of factors serving to build up inflationary pressures in the current market conditions is daunting. Inflationary expectations are on the rise and approaching multi-year levels in Russia and abroad. Commodity price pressures are also close to record-highs, with copper prices on the London Metals Exchange in early May hitting a record high of $10,460 a ton. Throughout the past year copper prices have nearly doubled and have reached their highest levels in the past decade. Commodity prices in the metals sector are mostly supported by China’s demand growth as well as the rising prominence of the “green recovery” agenda.
The record scale of stimulus and the resulting record-high growth in the money supply is another ingredient fueling inflation: the quantity of money in the US economy, measured by M2, has increased on a year-on-year basis in the beginning of this year by 26%, the largest annual percentage increase since 1943.
Another element in the global inflation equation is the disruption of production chains and the shortages in key inputs/components. Shortages of semi-conductors (including in China) and the disruption of supply-chains due to quarantine restrictions have generated computer shortages and price pressures in the manufacturing segment of the global economy. The rising prominence of the ESG/environmental agenda is another pro-inflationary factor as cost-push inflation is boosted by rising outlays by companies and the state administrations to raise environmental standards. Still more inflationary pressure is coming on the back of rising protectionism and competitive exchange rate depreciations.
At this stage the base-case of the Federal Reserve appears to be that the increase in inflation is temporary, which allows the US monetary authorities to gradually lift rates starting from the end of 2022. Alternative scenarios suggest that inflation could continue to exceed expectations, leading the Fed to start increasing rates already towards the end of this year. The Fed rate could then approach 2-2.5% already in 2022, with the 10-year US Treasury yields reaching 3-3.5% and the US dollar appreciating by as much as 10%.
In the end the range of scenarios is quite wide – from the lingering risks of falling demand and deflationary pressures, to some of the observers starting to ponder the risks of hyperinflation. The result will depend on the course taken by the regulators and at this stage the markets are increasingly going to focus on the time-frame of the withdrawal of economic stimulus in advanced and emerging markets. The data of the past several months suggests that the time-frame for such decisive and difficult steps is likely to be brought closer to the present time-frame.