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By: Rhona O'Connell, Head of Market Analysis
Prior to the escalation of the issues in the Black Sea region, then the answer would have been that the resolution of supply chain dislocations – which would still have been some months away - would have taken some heat out of the situation and brought inflation back down towards a manageable 2‑3%. Resolving that issue would mean that price pressures, especially those revolving around semiconductors and thus cascading into any number of industries, would fall away and the additional component of high freight rates would ebb away also.
The Russia/Ukraine issue, however, changes the complexion. Russia and Ukraine between them account for 30% of world wheat exports, for example and while there is evidence that some boats are getting out of China, nothing is moving from Ukraine and the supply shortfall is likely to contribute to food inflation (which is particularly high in Russia at almost 10%). This could of course be mitigated if other producers, notably Australia, can fill the potential void.
Of more significance is the impact on energy, with Brent now trading in the region of $114/bbl, up 48% year on year and gas oil at $1,181/t, up 77%. As and when the situation is resolved then the heat will come out of these markets, but with energy at 7% of CPI in the States, then this sector will continue to prop up prices for the next few months and the legacy at the retail level may persist for longer than that, especially with the strengthening labour market in the United States, with strong nonfarm payroll figures becoming the norm, especially for February, which was a long way above expectations, and with unemployment falling to 3.8%
Overall, therefore, the case can be made that this spike should work through in the next few months, but if central banks are to avoid knocking economic recovery off course, then the acceptable underlying manageable level of inflation may well have to be re-set towards 3%.
Major sovereign yield curves
Source: Bloomberg
And as a final note; at present, among the States, the EU region as a whole and China, the only nominal interest sovereign rates that exceed 3% are in China, starting over 15 years hence. On balance, the geopolitical risks in the system, as well as their exacerbation of tightening commodity supply chains, as well as the prevalence of negative real rates around the world, continue to favour gold, although the checks and blackness of a reversal in Asian demand will help to keep something of a cap on prices.
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