Jim Power: Supply strain to worsen further before it gets better

Jim Power: Inflationary pressures are building on many different fronts, and central banks appear somewhat bemused and unsure about how to respond on the monetary policy front.

For at least a decade, the only conversations about inflation in economic and financial market circles was really about the lack of it and the desirability of generating some.

Hence, we have been living in a world of historically low short- and long-term interest rates for a prolonged period and central banks around the world have been pumping liquidity into the global financial system through quantitative easing (QE).

Alas, the world has changed in dramatic fashion in recent months, inflationary pressures are building on many different fronts, and central banks appear somewhat bemused and unsure about how to respond on the monetary policy front.

Initially, they argued that the surge in inflation was transitory, and while they still seem to believe that, the transitory period appears to be lengthening.

The price pressures are evident on many fronts. Energy costs are rising strongly, with natural gas, coal, oil, and many other commodity prices rising very sharply. 

These energy price increases are due to a confluence of factors including strong demand, supply constraints following Covid, the transition away from fossil fuels in electricity generation, and numerous political factors.

In a sense, energy prices are being hit by a perfect storm, and we have no real idea as to when the storm might abate.

In the year to September, average consumer prices increased by 3.7%, which is the highest rate of inflation since June 2008.

Shipping costs are also rising strongly due to a scarcity of shipping containers and ships. This is feeding through to higher prices and supply-chain problems.

If shipping costs rise, inevitably this will result in higher wholesale and consumer prices.

Construction costs are also rising strongly around the world due to material shortages. 

Labour shortages in some sectors are also obvious, which is also upping wages. Semi-conductor chips are also experiencing significant shortages, which amongst other things, is causing serious problems for car manufacturing and is pushing up both new and second-hand car prices.

In short, the world economy is experiencing the first supply shock since the two oil price shocks of the 1970s. 

It may just be a reflection of the massive multi-faceted dislocation caused by Covid, but the danger with inflation is that it can become embedded in the system and an old-fashioned wage-price spiral could develop, and come up against strong demand-led price rises. 

This is the most challenging price environment we have lived through in some years.

Ireland is not immune from these widespread inflation pressures at both the producer and consumer level. In the year to September, average consumer prices increased by 3.7%, which is the highest rate of inflation since June 2008.

Transport costs increased by 11.4%, mainly due to fuel costs; private rents increased by 5.9%; alcoholic beverage and tobacco prices were up by 4.9%; petrol prices increased by 12.5%; diesel prices increased by 13%; and home heating oil increased by a frightening 39.3%.

We are entering into a winter of significantly higher costs of living and costs of doing business, but the hope is that the supply-side constraints will abate in the spring and that we will settle down to a more normal inflation environment.

However, things are likely to get worse before they get better.

In Budget 2022, last week, the minister for finance warned about further risks to inflation and the cost of living, and hence there was some limited attempts made to protect some people from higher cost of living pressures.

For central bankers, a new world has emerged, and with the vulnerabilities evident in the global economy and with elevated government debt levels, the notion of increasing short-term interest rates and pushing up government bond yields is not very appetising.