Many people may refer to last year as the global "year of inflation" - the year-on-year growth rate of the US CPI once exceeded 9%, and the inflation rate of major European economies even reached double digits. And now, as 2023 is also coming to an end, has the former global "inflation panic" come to an end? In a World Bank blog published on Monday this week, World Bank economists are trying to find answers for people.
World Bank economists have stated in their blog that the high inflation rate, which has forced global central banks to raise interest rates at the fastest pace in decades, seems to be expected to continue cooling down in the coming months, but risks still exist.
These economists wrote in their blogs that the huge inflation panic in the post pandemic era was driven by a series of adverse shocks in the past four years. After the initial collapse of the pandemic in early 2020, global inflation began to rise later that year as demand rebounded, supply bottlenecks tightened, and oil prices rebounded. After the outbreak of the Russia-Ukraine conflict, global inflation further hit a peak due to the soaring oil and food prices and the re emergence of supply disruptions.
However, since July 2022, global inflation rates have steadily declined (Figure 1).
Professional forecasts, inflation expectations based on financial markets, consumer surveys, and model-based estimates all point in the same direction: global inflation will only continue to decline in the coming months (Figure 2).
Note: The left side represents the expectations of developed economies, while the right side represents the expectations of developing economies
With the support of this consensus, the financial market currently expects major central banks to cut interest rates in the first half of next year (Figure 3).
Note: The red line represents the Federal Reserve's interest rate level, and the blue bar represents the European Central Bank's interest rate level
So, has the inflation panic come to an end? The message sent by major central banks last week gave a different answer: the Federal Reserve sent a signal that it may shift its policy stance, bringing its interest rate trajectory closer to market (rate cut) expectations. But the European Central Bank and the Bank of England still adhere to their previous positions, believing that it is only possible to shift policy stance when there is reliable evidence of sustained decline in inflation.
World Bank economists point out that people have reason to be optimistic about this. In the coming months, many factors will drive global inflation further down. But before that, caution is still needed. Some risks still exist, which may delay the decline in inflation rates or reignite price pressures.
Optimistic reasons in the eyes of the World Bank
The World Bank points out that all fundamental drivers of inflation indicate that global inflation is expected to decline in the coming months: global demand is slowing, supply disruptions are subsiding, commodity prices are slowing, and monetary policy remains restrictive. Inflation in various countries is highly synchronized, which means that these factors may drive global inflation to continue to decline.
To take a closer look:
In the context of tight financial conditions, weak global trade, and limited fiscal support, it is expected that global demand will slow down next year. Global demand related factors account for nearly 30% of inflation changes (Figure 4). As global economic activity slows down, the impact of these demand related factors on inflation will become smaller and smaller.
Note: The contributions of each factor to global inflation, from left to right, are oil prices, global supply chains, global demand, and interest rates, respectively
The easing of global supply chain pressures is expected to also contribute to a decrease in global inflation rates. Due to the widespread weakness in commodity trade and the gradual disappearance of supply disruptions during the pandemic, these pressures have recently reached historic lows. Although the labor market remains tight, job vacancies have gradually decreased, and wage growth in the United States and some other developed economies has generally slowed down.
After a 17% decline in oil prices this year, it is expected to continue to decline in 2024 as weak global economic growth will alleviate demand pressure. Oil prices play a crucial role in driving overall global inflation, as the post pandemic developments have clearly demonstrated. In fact, oil price fluctuations account for approximately 40% of inflation fluctuations.
In addition, the monetary policies of major economies will remain restrictive to ensure that inflation rates return to central bank targets. Despite recent declines in inflation rates, all three major central banks (the US, Europe, and UK) have reiterated their intention to maintain high policy interest rates until convincing evidence of price pressures disappearing. This means that even if central banks begin to cut policy rates in the future, they will maintain interest rates at a sufficiently high level to keep prices down. The lag and sustained impact of high real interest rates will continue to weaken global economic activity, thereby further easing inflation in the coming months.
Two points that the World Bank is still concerned about
However, the World Bank also mentioned that there are at least two key reasons that require us to be cautious about the pace of future deflation: geopolitical tensions may trigger another inflationary shock, and the sustained pressure brought about by high core inflation rates. Central banks around the world still need to worry about whether they can bring inflation within their target range without causing a sharp decline in economic activity.
In the past 14 months, the decrease in global core inflation rate has been smaller than the decrease in overall inflation rate (Figure 5). Due to strong demand and sustained price pressures in the service industry, the decline in core inflation rates has been limited. Looking ahead, core inflation rates must continue to decline in order to convince central banks around the world that inflationary pressures have been firmly controlled. This may require further slowdown in demand, especially in the service industry, as well as a weak labor market.
Note: The blue line represents the global inflation rate, while the yellow and red lines represent the inflation rates of developing and developed economies, respectively
In the past few decades, geopolitical tensions have been a key factor in triggering inflation. Following the chaos caused by the Russia-Ukraine conflict, the recent conflict in the Middle East may destabilize the global energy market, thus becoming another major driver of the resurgence of inflation. Although the impact has been limited so far, due to the region's oil production accounting for nearly 30% of global production, escalating conflicts may lead to a significant increase in oil prices. If oil prices rise by 10%, global inflation will rise by 0.35 percentage points within a year. If there is a significant second round impact on wages and broader production costs, and inflation expectations rise, then the rise in oil prices will also affect core inflation.
The World Bank points out that although global inflation rates have fallen in the past year, two-thirds of countries setting inflation targets still have inflation rates higher than the target value (Figure 6). Professional forecasters predict that even by next year, more than two-fifths of these countries will still have inflation rates higher than the set target. The inflation rates of many developing economies have declined in the past two years, but more than one-fifth of these economies still maintain double-digit levels.
Note: The proportion of countries above the target value is represented by the red column for developed economies and the black column for developing economies
Central banks around the world are unlikely to significantly lower interest rates until they are confident that inflation rates are firmly within the target range. This means that monetary policy will continue to be restrictive. The potential chaos in the global energy market and supply chain may prolong the current dilemma faced by many central banks - how to lower inflation rates to the target range while achieving a soft landing.
Therefore, World Bank economists believe that the recent decline in inflation is a welcome sign, but it is still too early to open champagne. There are still some risks that may slow down the decline in inflation rates and even push them up. Due to the fact that inflation is often synchronized globally, a rebound in inflation in developed economies may also harm developing economies.