By Jorge Alvarez and Philip Barrett
The war in Ukraine will accelerate inflation, which we now expect to remain elevated for longer than previously anticipated due to higher commodity costs and broader price pressures.
As Chart of the Week shows, our latest World Economic Outlook now projects faster consumer price increases this year for advanced economies as well as emerging market and developing economies. These forecasts also have a high degree of uncertainty.
Russia’s invasion of its neighbor is likely to have a prolonged impact on commodities, hitting oil and gas prices more severely this year and food prices well into next year.
Four main factors shape our perspective:
- The war aggravated the prices of raw materials that were already rising. Energy and food helped drive inflation last year, due to tight oil and gas supplies after years of subdued investment and geopolitical uncertainty. This was one of the main drivers of inflation in Europe and, to a lesser extent, in the United States. Rising food prices also played a role in most emerging market and developing economies, as extreme weather reduced harvests and rising oil and gas prices pushed up energy costs. the fertilizers.
- Demand surged last year amid supportive policies, while supply bottlenecks grew from factory closures, port restrictions, shipping congestion, container shortages and worker absences. As a result, inflation rose, especially where recoveries were strongest. Demand should decline this year as policy support is withdrawn and supply bottlenecks are eased, but recurrent lockdowns by China, the war in Ukraine and sanctions on Russia are likely to prolong disruptions in supply. some sectors until next year.
- Demand is also rebalancing from goods to services. Spending shifted to goods as pandemic restrictions disrupted in-person activities, and supply bottlenecks helped boost goods prices. Although services inflation started to pick up last year, pre-crisis spending patterns have not fully returned and goods inflation remains significant in most countries. The demand for services will increase further as the pandemic subsides, and headline inflation should return to where it was before the coronavirus.
- Labor supply remains tight after significant tightening in some advanced economies such as the United States and the United Kingdom. The shortage of workers, mainly in contact-intensive industries, is driving up wages, although inflation has eroded wage gains. Meanwhile, the pandemic reduced labor participation in advanced economies. These changes appear to be related to early retirement and workers who are unwilling or unable to return as infections continue. Some workers are putting in fewer hours. We assume labor supply will gradually improve this year as the health crisis subsides, but the effects will be modest and unlikely to significantly ease upward wage pressure.
Under these conditions, we expect already high inflation to persist for longer. Our projections indicate that the pace in advanced economies will hit a 38-year high of 5.7%, while price increases in emerging market and developing economies will accelerate to 8.7%, the fastest pace since the global financial crisis of 2008. Those rates will then cool next year to 2.5 percent and 6.5 percent, respectively.
Importantly, rising prices will have the greatest effects on vulnerable populations, particularly in low-income countries. High headline inflation will also complicate central banks’ trade-offs between containing price pressures and safeguarding growth.
While our base expectation is that inflation will eventually decline, inflation could rise for a number of reasons. Worsening supply-demand imbalances, including due to the war, and further gains in commodity prices could keep the pace of inflation persistently high. Furthermore, both war and new pandemic outbreaks could prolong supply disruptions, further increasing the costs of intermediate inputs. In a context of tight labor markets, nominal wage growth could also accelerate to catch up with consumer price inflation, as workers seek higher wages to preserve their purchasing power. This would further intensify and amplify inflationary pressures, with the risk of de-anchoring inflation expectations.