High inflation forcing central banks to taper early and hike rates

Global financial market investors pay attention to monetary policies and interest rates as they have a direct influence on the value and performance of their investments. Central banks around the world use monetary tools to stimulate economic growth and control inflation.

The current global economic cycle is made of low-interest rates, relatively high quantitative easing packages, and massive fiscal stimulus packages designed to create an environment for a V-shaped economic recovery from the Covid-19 pandemic.

This economic environment is the perfect recipe for high inflation and global economies are beginning to feel the heat at household and corporate budgets. In Kenya, the November inflation rate stands at 5.80% according to the latest data from the Central Bank of Kenya.

This is happening at a time when interest rates are at record lows of 7% and the government is involved in stimulus packages to support recovery and growth.

In the US, the November inflation rate stands at 6.8% making it the sharpest rise since 1982. This is happening at a time when the federal funds rate is in the 0.1%-0.25% range.

About a month ago, President Biden signed a $ 1.2 trillion infrastructure bill into law thereby releasing a massive fiscal stimulus into the US economy to support recovery and stimulate economic growth. There is also another $ 1.75 trillion social spending bill pending in Congress.

The Eurozone, United Kingdom, Switzerland, Australia, and New Zealand are also experiencing similar economic features. Low-interest rates, massive quantitative easing programs, and rising inflation rates.

So, what is causing the high inflation rates?

There are a couple of factors that are contributing to the high consumer prices in retail businesses, education, housing, entertainment, medical care, communication, transportation, among other sectors.

First, we have an abnormal pressure arising from cost-push inflation. Oil prices have risen 68% in 2021 before erasing gains down to the current 44%. Oil is a major factor of production in the world and an increase in oil price raises the cost of manufactured goods hence retail prices.

This has had a significant influence on the high consumer prices we are currently experiencing.

Unemployment rates have significantly dropped in major economies thereby forcing wages to rise. In the US, there is a current trend in the job market dubbed ‘The Great Resignation’. It is a trend where people are resigning from low-paying jobs while seeking higher-paying jobs with better working conditions such as work-from-home arrangements.

Since labor is a major factor of production, organizations are being forced to hike their product prices to afford higher wages. This trend is spreading to European and Asian countries.

For net importers, that is, countries that import more than they export, there exists significant imported inflation. This is where the cost of imports increases leading to higher prices of consumer products. In Kenya, being net importers, we have seen significant price increases because of an increase in import prices.

The effect of central banks lowering interest rates to record lows has raised the appetite for debt. This has increased the money supply thereby raising inflation. In Kenya, the additional steps by the president to suspend CRB listing of loan accounts below KES 5 million has increased loan access and may lead to higher inflation in the near term.

Quantitative easing and fiscal stimulus packages have increased money supply and raised business & consumer confidence. This has increased the money supply and inflation rates as a result.

How does high inflation affect you?

High inflation means that your money today buys fewer products compared to the same amount in the same period last year. To the high-income earners, it may not be that significant. However, to the low-income earners, it significantly hurts their budgets.

For instance, a household surviving on a KES 20,000 monthly income at a 5.80% annual inflation rate will only be able to purchase (100% - 5.80%) = 94.20% of the stuff they used to purchase in the same period last year. This means that they must do extra work to maintain the same quality of life.

If they don’t get such a working opportunity or a salary raise, they may be forced to forego some spending such as health insurance or simply reduce their quality of life just to survive.

For persons with an income surplus, they may be forced to reduce their savings and investments just to maintain the same standard of living. In summary, inflation reduces your purchasing power through higher consumer prices. In the book, you will have the same amount of money, but it will buy less stuff.

To protect households from the negative effects of high inflation, central banks may be forced to reduce the gas on quantitative easing programs, and hike interest rates to reduce the money supply, hence inflation.

South Africa, Mexico, Australia, Switzerland, and the United Kingdom may be leading this race, but all other central banks may be forced to follow suit in 2022. This will be very instrumental to cool off the red-hot housing markets in developed countries as well as the rising consumer prices.

Rufas Kamau, Research & Markets analyst, Scope Markets Kenya