Countries worldwide are suffering from record high inflationary pressures moving away from their targets reaching the highest inflation rates in decades exceeding the 2008 Financial crisis figures, as shown below. Supply chain constraints, arising from increased global demand for goods and services as the economy was recovering from the pandemic, as well as, the Russian-Ukrainian war trebled the inflationary pressures.
In March 2022, the Eurozone CPIH y-o-y reached 7.5% in March 2022 increasing from 5.9% in February 2022, in which the Spanish inflation reached 9.8%, Germany reached 7.6%, French inflation reached 5.1%, the US reached 7.9% in February, and the UK inflation rate increased to 6.2% in February of 2022 from 5.5% in January which is the highest acceleration since March 1992, as shown in figure 3, surpassing the market forecasts of 5.9%, and surpassing the Bank of England's (BoE) inflation target of 2%.
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Figure 1: Monthly CPI Inflation Figure2: Countries with inflation above target
Source: Haver Analytics, World Bank Group (WBG) Data (March 2022)
Focusing on the UK, the most notable increase in the UK annual CPIH from Jan to Feb was in the fuel prices for the transport sector at 11.5% reaching £1.48 per liter for petrol and £1.51 per liter for diesel. The overall CPI is expected to increase further to 8% in Q2 2022; the Office of Gas and Electricity Markets (Ofgem) announced a higher than expected increase in gas and electricity price caps in April by 54%, along with the global increase in prices of natural gas. The effect of the supply chain disruption in the microchips industry rippled to other industries indirectly; the decrease in the production of new vehicles caused an increase in the 12-month used car prices to increase to a record high of 28.7 % in January. Also, food prices increased by 0.8% from 4.3% to 5.1%, and the house price index increased by 14.3%, the most annual gain in nearly two decades. Those price hikes pushed people to increase their credit borrowings in which consumer credit increased by about USD 2.46B in February, the biggest increase since March 2017, and with the increasing interest rates, those borrowers will be adversely affected.
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Figure 3: Source: Office of National Statistics (March 2022)
One way to combat inflation is by changing interest rates. Therefore, the BoE reviewed the borrowing interest rate three consecutive times from 0.5 in Feb 2022 to 0.75 in March 2022, as shown below. It is expected to reach 1% by May 2022. And as interest rates on borrowings increase, consumers spend less which translates into less revenue for businesses. Moreover, as interest rates increase, investors tend to turn to healthcare, consumer staples, energy, financial stocks, etc.
UK Interest Rates on borrowing (2012-2022)| Source: Trading Economics (March 2022)
In addition, BoE will use another tightening monetary policy which is cutting purchases of government bonds (aka gilts) for the first time since 2009. It is expected that the BoE will start the unwinding process once the interest rates reach 1% to sell USD 148B worth of gilts over the next 3 years, according to a BoE survey. Consequently, the bonds sale will affect the stock market. As bonds' sales increase, their prices decrease and their yields rise which spells higher risk.
The ambiguous outlook as the war in Ukraine persists poses serious policy challenges for central bankers. However, it does not mean deviating from the fundamental monetary instruments that have helped them over the past three decades since the great inflation of the 1970s.
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