Inflation round-up

In their constant fight to control inflation, central banks' main weapon is interest rates. By lifting the cost of borrowing, spending falls and the loss of demand slows price rises. But each central bank only has one headline interest rate to play with, so they can only aim at one target. In other words, they must choose the most likely outcome given current conditions and adjust interest rates accordingly. They cannot set monetary policy to cover multiple possible scenarios and, no matter how alarming it might be, the worst-case scenario often has to be ignored (despite what some might suggest).   

The huge shock of Russia's invasion of Ukraine caused a rapid rise in inflation globally in 2022 and many countries' indices remain high because of it even now (see first table below). Many commentators have warned that the Israel/Hamas war could bring a repeat and some have criticised central banks for being too relaxed about inflation.

But there are big differences. Russia and Ukraine are dominant exporters of staple food items such as grains and oils, plus fertilisers, and Russia is among the world's biggest energy suppliers. Israel trades lots of manufactured goods and some natural gas, but it is not a big cog in the globalised economy like Russia was. Furthermore, the world is not trying to lock Israel out of financial and trading systems, whereas the heaviest sanctions were imposed on Russia. Destruction in Israel, awful though it was on 7 October, was minuscule compared with the devastation of Ukraine. Israel now seems set on destroying Gaza, but because of its stranglehold on the territory run by Hamas over the last two decades and more, Gaza is almost an irrelevance to the global economy.

So, when Russia attacked Ukraine in February 2022, vital parts of global supply chains clogged up overnight, while countless businesses in both countries had to stop production. Serious shortages of numerous goods followed, causing prices to soar. Europe had to re-source almost its entire energy supply, while Africa scrambled to find new wheat and other supplies, often at much higher prices, but nearly every country in the world was affected in some way. There is little equivalence with the situation in Israel and Gaza.

It is always possible that the fighting in the Middle East will spread and, indeed, that seems to be the main argument of the alarmists on inflation. Some directly-related violence has been seen in Lebanon and Syria, for instance, but unless major oil producers like Saudi Arabia, United Arab Emirates and Iraq become involved, there will almost certainly be at most a limited impact on prices around the world. With Hezbollah in Lebanon appearing to show restraint and its backer, Iran, also seeming cautious, the worst-case scenario of a wider war looks an unlikely outcome at the moment. That creeping realisation has prompted oil prices, which did initially jump after 7 October, to fall back again, bringing fuel and utility prices down with them. In fact, if the Israel/Hamas war is to have a major impact on prices round the world, it will probably be a disinflationary one, because it provides yet another geopolitical uncertainty likely to reduce investment and economic growth. Aiming to temper that scenario, rather than the much less probable one of runaway inflation, is the reason most central banks have stopped raising interest rates, even though inflation remains elevated in many countries.

Fortunately, the alarming rise in oil prices two months ago, which also prompted warnings of a potential new bout of high global inflation, quickly retreated, allowing our table of double-digit inflation countries to shrink again. There are now 29 countries on the list; a year ago there were 75. Despite this good news, high prices continue to have a big impact on the costs of international assignment packages, as rents for accommodation and nursery and school fees, for instance, have increased dramatically in many locations.

Food prices are especially volatile, largely as a result of climate heating. An oversupply of pork has brought down costs in China, where the consumer price index is now back in deflationary territory. Russia, meanwhile, has enjoyed fruitful harvests this year, providing much of the world with wheat at the lowest price for three years. Elsewhere though, historic droughts have sent sugar and cotton prices soaring in India, olive oil costs doubling in Spain and beef prices hitting record highs in the United States. At the same time, export restrictions and extreme weather are harming the global supply of rice, a staple food relied on by many millions of people.

Finally, two sizeable VAT changes to alert you to: Laos plans to reverse its VAT cut of 2022 by raising the sales tax from 7% to 10% in early 2024; and Sri Lanka has confirmed it will lift VAT to 18% from 15% on 1 January 2024.