Economy 3 MIN READ

Up and up: Why are prices soaring lately?

We can expect prices to soar as demand continues to rise amid constrained supply

May 5, 2022By Renz Calub

While the reopening of the economy gives a sense of optimism to many, food and fuel prices are rising. The latest inflation figure – the year-on-year change in the consumer price index (CPI) – was recorded at 4.9% in April 2022, almost 100 basis points (bps) higher than that in March. It is already beyond Bangko Sentral ng Pilipinas’ (BSP) target range of 2-4%.

The Philippine Statistics Authority (PSA) attributes this uptrend to accelerating food prices, energy prices, and transportation costs. But what exactly is driving the soaring prices?

As an investor, inflation matters because soaring prices mean costs will just escalate, and you will be able to purchase much less than before because your assets can’t keep up.

Recovering demand, revenge spending

With more people staying home and businesses shutting down in 2020, demand destruction ensued.

COVID-19 changed the economic landscape in 2020. Governments implemented lockdowns to curb the virus, halting economic activity. Demand destruction ensued as people had to stay home and businesses had to shut down. With low demand, inflation slowed down. Philippine inflation for 2020 averaged at 2.6%, with the figures settling at a low 2% range in the height of ECQ-MECQ.

This changed in 2021 when COVID-19 cases started to fall, and vaccines started rolling out. Governments have begun to work their way towards recovery and to slowly reopen their respective economies. The reopening resuscitated the destroyed demand in 2020, and this was even reflected in the 2021 Philippine GDP growth of 5.7%. Some studies even pointed out that consumers were ready to engage in “revenge” spending, planning to spend more on retail shopping, discretionary spending, and other large purchases.

Higher consumer and investment spending are supposed to be good for the economy, right? Not if the supply can’t catch up to support such spending, which leads to higher prices.

Soaring demand and supply disruptions led to higher prices of goods.

Supply crunch and geopolitical tensions

Despite the renewed drive to spend, global supply chain issues and geopolitical tensions threaten to buckle the global economic recovery through higher prices. For one, COVID-19 is still present and surges in the number of cases have prompted some countries to reimpose mobility restrictions, which can disrupt the flow of goods across the world.

Even if there is demand, if there are fewer goods coming through, prices will increase. Recently, China reimposed lockdowns due to their zero-COVID policy, halting the flow of goods through their ports and thereby disrupting global supply chains.

Importantly, the recent rise in prices is partly exacerbated by the ongoing war between Russia and Ukraine. While the Philippines is not directly involved, the country bears the brunt of higher fuel costs and, consequently, higher commodity prices since food and other essential goods are now more costly to transport across the country.

The economic sanctions imposed by the West on Russia in response to its invasion of Ukraine have constrained the supply of oil across the world. Russia produces about 11% of the world’s total oil, and the expected reduction in oil supply drove crude oil prices to as high as USD 130/barrel.

This explains why domestic gasoline and fuel prices have reached about PHP 70-P80 per liter. Furthermore, it appears that this higher fuel cost will stay for as long as the West does not lift the sanctions even if Russia halts the war against Ukraine.

With demand continuously picking up amid constrained supply, prices are expected to soar further. The BSP, which can slow down inflation by hiking interest rates, has so far favored non-monetary policy measures (such as fuel subsidies) to cushion the effect of higher fuel prices especially in the transport sector. It has also maintained its 2% key rate in favor of sustained demand expansion. Currently, markets are expecting the BSP to start hiking rates, perhaps as early as June 2022.

(In part 2, we shall talk about inflation forecasts and why they are updated every so often. For investors, it is imperative to have at least some projection on how fast prices will go.)

RENZ CALUB is the Deputy Head, Research and Business Analytics Department, of Metrobank.

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