Many hands at play
As we move past the one-year anniversary regarding the invasion of Ukraine, many might feel the inflationary impact is diminishing. A relative example of this is shown with European gas prices; and how they have dropped to levels below what they were trading at before the invasion. Although the risk of future energy spikes is far from over, the huge inflationary impulse from the war in Ukraine has dissipated for now.
Supply chain constraints also had a significant impact on inflation although many believe these covid-related bottlenecks are largely behind us. Price premiums in key sectors, such as autos are disappearing for one. And price pressures appear to have peaked within the certain manufacturing sectors.
Central banks, who have recently played a large role, reacted to the pandemic by following the same game plan they used for the global financial crisis: the use of quantitative easing. But as 2022 was a year of central branks trying to regain credibility and monetary policy; now many are witnessing quantitative tightening. As quantitative easing has given way to quantitative tightening, many feel balance sheets are wound down and excess liquidity is being withdrawn.
Still a cautious tale
Many of the above factors all suggest that inflation is headed downwards, but there are still many stubborn issues that may say otherwise. It could still spell out to be a cautious tale as other factors may very well keep inflation higher than expected.
Breaking down some of these factors include wage expectations, China, commodities, and other potential wildcards. Whereas goods inflation is largely driven by transportation costs and supply chain costs, services inflation is largely driven by wages, and wage expectations. Similarly, China’s reopening could be both inflationary and disinflationary. The reopening of supply chains is disinflationary, but as a significant source of global demand, China’s opening will be inflationary on consumer goods and commodities.
Oil and commodities in general, continue to be a bit of a wildcard. Commodity prices declined in the second half of 2022 as many felt this was no longer a significant source of inflationary pressure. However, although the U.S. announced that after drawing down its strategic petroleum reserves last year, that it will reverse that policy and begin buying oil back in 2023. It is unclear where we move from here as there could be potential for long-term supply gaps. And if long-term demand continues to grow, prices in the end may get affected.
As always, data is key
As we move further into 2023, many believe inflation data will likely prove to be encouraging, with markets growing increasingly confident that the peak is potentially in the past. Staying prudent, such calls could be misplaced and, unless economic activity deteriorates significantly, major central banks are likely to take a cautious view.
As such, it is possible that cuts are still some way off and that central banks will need to see clear evidence that service sector inflation has started to moderate before having
the confidence to ease policy. Many feel this is unlikely to occur until the end of 2023 at the earliest.
However, in the longer term, the question remains on how the disinflationary impulse from goods prices may fade, leaving central banks potentially facing a far more challenging environment than seen previously.