What an inflation shock really looks like

The 80s is in fashion again. Top Gun is back in the cinema, Kate Bush is number one, and inflation is at its highest since 1982. There’s a conflict going on too, which threatens global food security like no time since the Second World War.

Early in 2021, UK inflation was running at less than 1%. Now it’s 9%, a 40-year high! Costs in America are 8.6% more than a year ago, and in the eurozone they’re up a record 8.1%. Shockingly, the cost of living is likely to increase even further in the months ahead.

Who to blame? Well, the war in Ukraine has made things considerably worse, but it wasn’t Putin’s march west that triggered the surge in global commodity prices, or the cost-of-living crisis. Energy prices had begun creeping up over a year ago following an unusually cold winter and a surge in global demand for gas after the pandemic. Wind hasn’t created as much power as expected either.

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Labour shortages – remember when lorry drivers were like hen’s teeth? – and more expensive fuel, increase transport and distribution costs for businesses. That includes the commodities sector. And guess who pays for it?

Now, when you add the Ukraine conflict into the mix, wiping out a massive chunk of global wheat production, then factor in sanctions against Russian oil and gas etc, you get the supercharged inflation we’re seeing now. Even some kind of peace deal – as far away as ever at the time of writing - would take time to wash through the system and lower prices.

“Commodity prices are currently disconnected from fundamentals: Commodity prices are structurally driven by cost of production and cyclically driven by inventory levels. As consumers are willing to pay premiums to guarantee supply, prices detach from fundamentals.” Morgan Stanley

According to the World Bank, food commodity prices hit a record high during March and April. A 15% jump on the previous two months put them 80% higher than two years ago. It expects a 20% increase in food prices in 2023 as global wheat supplies decline again.

Most recently, the Institute of Grocery Distribution predicts food prices will rise 15% over the summer. A massive reduction in wheat exports out of Ukraine and Russia is driving up the cost of grain, so watch the price of bread and pasta rocket. Anything fed on grain, like chickens, will get significantly more expensive too.  

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Even glass half-full US investment bank Morgan Stanley, which considers itself “below consensus” on food price forecasts, accepts that current elevated levels are not fully reflected in what consumers are paying at the till. “The impacts will be felt over the next 12-18 months,” it warns, adding that the risk of a "domino effect" of governments restricting food exports, like India has done with wheat, is very real.

Now, central bank policymakers the world over must decide how aggressively they can hike interest rates to curb inflation, while at the same time avoiding a global recession. Not an easy job. This is one best watched peeking through your fingers.