The inflationary consequences of Russia’s war will spread – from the Economist – 14.03.22
- Michael Julien
- Mar 15, 2022
- 2 min read
Inflation, already high, will go higher still. What will central banks do?
LAST SUMMER, amid mounting alarm about inflation in America, economic advisers in the White House penned a blog post in which they examined historical parallels for the building price pressures. Although the press was full of comparisons with oil shocks in the 1970s, they wrote that a nearer relative was the dislocation after the second world war, when supply shortages interacted with pent-up demand to drive up inflation. It was a well-reasoned argument. But the surge in oil prices over the past month, in the wake of Russia’s invasion of Ukraine, gives rise to an unsettling question: is the global economy now seeing a 1970s-style oil shock on top of a late 1940s-style supply crunch?
To be sure, no serious economist expects inflation in the rich world to reach the giddy double-digit heights of those episodes. Nevertheless, the oil shock is a painful development. According to figures released on March 10th, consumer-price inflation in America already stood at a 40-year high in February, at 7.9% year on year; the rate in the euro area exceeded 5% (see chart 1).
Prices had been expected to come off the boil as the rich world put the worst of the covid-19 pandemic behind it. Now the new consensus is that inflation will remain uncomfortably high in America, Europe and elsewhere over the coming months. And as if any more bad news were needed, rolling lockdowns in parts of China, including the tech hub of Shenzhen, could add to supply-chain strains.
The most striking evidence of the upward shift in inflation expectations can be found in fixed-income markets in America. ICE, a financial firm, distils a few different numbers, including yields on inflation-protected bonds and interest-rate swaps, into short-term and long-term indices for gauging expectations. In late January the expected rate of inflation over the next year was 3.5%. By March 11th, it had soared to 5.6%, far and away the highest since the pandemic began (see chart 2).
At the same time, longer-term indices have been a little calmer. A gauge of expected average consumer-price index (CPI) inflation over the course of five years, starting five years down the road, is 2.6%. That is about half a percentage point higher than a year ago, but not terribly far off the Federal Reserve’s goal of keeping inflation to an average of 2% (as judged by another measure that is typically somewhat beneath the CPI gauge). Europe has seen similar, if slightly steeper, trends. The one-year inflation swap rate rose to 5.9% on March 8th.
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