Global high inflation: A supply-side problem

Recently, global equity markets, especially in the US, have tumbled and gone into bearish territory (with the NASDAQ and the S&P500 dropping at least 20% in index value). This is coming mainly from the fear of high inflation pushing central banks, such as the US Federal Reserve, to hike rates aggressively and inadvertently push the economy into a recession, a so-called “hard landing”.  

Rate hikes are supposed to cool down demand by pushing up the cost of borrowing, making it less attractive for borrowers to push through with their economic activities. Additionally, it can push investors to simply park their funds in competitively priced safe assets to offset inflation, further bringing down activity in the real economy and thus helping bring down inflation.  

The problem is that the current rounds of inflation are not coming from such demand-side pressures but more from supply-side issues. For one, the COVID lockdowns disrupted the global supply chains and caused huge bottlenecks and logistics constraints when demand did eventually come back.  

In the US especially, the Biden administration reversed the energy policies of the previous administration and pushed for clean energy. Thus, with the start of the Russia-Ukraine war, sanctions and counter-sanctions have turned the energy markets upside down and have pushed up energy inflation, with the US in no position anymore to offset the oil supply disruptions given their policy reversals. 

High food and energy prices  

Food commodities have taken major collateral damage with the disruptions in fertilizer production and in the transportation of major food supplies, causing food inflation on top of energy inflation. The result has been a perfect storm wherein higher food and energy prices have been pushing up inflation prints all around the world, the Philippines included.   

In the US, inflation threatens to hit double-digit numbers and markets are penciling in aggressive Fed rate hikes in the coming meetings, with some opining about hikes of about 50-75 basis points per meeting.  

However, it remains to be seen how effective these rate hikes will be since the problem is really the lack of energy and food commodities available globally. It can still certainly help bring down second-round effects coming from demand suppression resulting from the rate hikes, but unless supplies come back and normalize, it might take time for inflation rates to come back down again anytime soon.  

More interest rate hikes 

This means that, for the Philippines, interest rates are expected to continue going up. The Bangko Sentral ng Pilipinas (BSP) has already started hiking rates and is expected to hike all the way to August at least, perhaps even more afterwards.  

The peso will continue depreciating as the Fed Fund rates go up, and, historically, the peso is very vulnerable to Fed rate action, appreciating when the Fed cuts rates and depreciating when the Fed hikes rates.   

More importantly, there is now talk in the newspapers of the government taking on a neutral stance in order to be able to secure food and oil supplies from all sides relative to the Russia-Ukraine conflict. This appears to be a very logical step to take in the face of the real problem with the current high-inflation scenario: that it is supply-side driven and that we need supply-side solutions rather than finance-side solutions. 

MARC BAUTISTA, CFA, is Vice-President and Head of Research & Business Analytics at Metrobank, in charge of the Bank’s macroeconomic, industry, and financial market analysis and research. He loves teaching finance and investments, portfolio management, statistics, financial derivatives, economics, etc. in a university setting. He plays guitar in a rock band and also loves learning other languages, especially Spanish, promoting its recovery as a heritage language in the Philippines.