Expect Inflation to Get Worse, Not Fall

A vendor sells his wares at Bang Khae Fresh Market in Bangkok. The central bank revised its estimate of the headline inflation rate for 2022 upwards to 4.9%. ARNUN CHOLMAHATRAKOOL

The economic theory is clear. Inflation always precedes a recession. Investors also think the same way. A recent live market poll conducted by Bloomberg shows that 15% of investors expect a US recession to start in 2022, 48% in 2023, 21% in 2024 and 16% in 2025 or later. late. Deutsch Bank also thinks the US economy could face a recession in 2023.

The last global recession dates back to 2008 following the subprime crisis. The recession ended after the US government injected US$1.5 trillion into a bank bailout and economic stimulus packages.

Fear of recession returns due to rising global inflation. In the United States, inflation in March stood at 8.5%, the highest since 1981. Preliminary data indicate that March inflation in the EU reached a high of 7.5% . At home in Thailand, March inflation is recorded at 5.73%.

The 2022 inflation is mistakenly thought to be caused by the high oil prices that occurred after Russia invaded Ukraine on February 24. The fact is that the inflationary pressure happened long before that. Consumer price inflation (CPI) in the United States was 7% in December 2021, 7.5% in January 2022 and 7.9% in February. More importantly, the US Producer Price Index (PPI) was already at 10.3% in February. Therefore, with or without the rise in oil prices due to the Russian invasion, consumer price inflation in March would be significantly higher than in February.

Inflation is caused by a mismatch between supply and demand and a panic reaction to supply and demand situations, for example speculation and hoarding. The root cause of the current inflation figures is a lack of investment in supply generation. Taking the energy sector as an example, average crude oil prices were $61.4, $41.3 and $69.1 per barrel in 2019, 2020 and 2021 respectively. At such low prices, oil producers had no incentive to develop new oil wells and service existing wells, resulting in lower production capacity. When demand rebounded from the Covid crisis, oil prices jumped to $96.6 a barrel in the first quarter of this year.

Even without Russia’s invasion of Ukraine, the global oil price would still hover around $100 (3,376 baht) per barrel in 2022 due to the mismatch between supply and demand. With a voluntary embargo on Russian oil, the world could see $110-120 a barrel as the normal oil price this year.

According to the International Energy Agency, about 1.5 million barrels per day of Russian oil is estimated to be avoided by world traders in April and, from May, almost 3 million barrels per day will not enter not in global markets due to international sanctions and buyers’ self-sanction. A major oil trader said the world could see oil prices near $150 a barrel.

Vladimir Putin knows the situation well and has ordered Russian oil companies to find new buyers in Asia. Currently, India and China are snapping up Russian oil at heavily discounted prices. However, things are not as easy as Mr. Putin imagines, as most Russian oil is drilled in Western Siberia and therefore expensive to transport to Asia; oil is more suitable for pipeline delivery to Europe. Asia receives oil produced on the island of Sakhalin, located near Japan and China.

Other raw materials share the same fate as oil and energy products. Commodity prices have soared 50% this year, the fastest rise in 27 years. Usually, there is a lag of three to six months before rising material costs translate into higher consumer prices. This is why the monitoring of producer price indices is as important as that of consumer prices. The US producer price index for March is 11.2%. In theory, within three months we could see double-digit consumer price inflation in the United States.

The inflation situation is likely to be severe in Thailand as the Thai government does not allow a gradual adjustment of commodity prices. A gradual rise in inflation would allow consumers to adjust their demand accordingly. Instead, the government controls the prices of essential goods. Currently, there are 46 price-controlled products and six price-controlled services, ranging from garlic to gasoline. But when prices are out of control, all hell breaks loose.

In March, the price at the pump rose 31.43% and electricity bills jumped 39.95%. Ready meals also increased by approximately 6.3%. But what Thai consumers are now facing is just the tip of an iceberg. Big inflation awaits in the coming months.

For starters, diesel subsidies will be halved from May. More importantly, inventories of all manufactured products over three months will run out in April/May, making room for more expensive products – reflecting the higher cost of energy and raw materials – to enter the market. . While the CPI for March is at 5.73%, the PPI for the same month is 11.44%, which is higher than that of the United States.

At this rate, Thailand could eventually see double-digit inflation like most countries in the world. In light of this, the Bank of Thailand may need to reassess its latest CPI projection of 4.9% for the year 2022. For Thailand’s CPI to remain at such an optimistic level, world prices oil may need to drop to $80 a barrel.

What comes after high prices are high interest rates. Some might say that the world is entering an economic recession because of high prices, so why do we need interest rate hikes that will make the economy worse? Well, high interest rates can delay and lessen the severity of an economic downturn.

Remember that 48% of US investors believe a recession will occur in 2023, while only 15% believe it will occur in the latter part of this year. This relates to the fact that the Fed (the US central bank) plans to raise interest rates by 1.0% this year. Higher interest rates would slow inflation and ward off recession.

Neither the Monetary Policy Committee nor the Bank of Thailand gave any guidance on Thailand’s interest outlook. However, they mentioned that the projected inflation of 4.9% is above its acceptable inflation target range of 1.0 to 3.0%.

If I may suggest to the committee and the bank, it is theoretically correct to raise interest rates now rather than later. A situation of high prices is not a short-term phenomenon, as the bank might imagine. This is a fundamental problem of shortage of supply due to lack of proper investment. It will take at least a year and more likely three years for supply to catch up with demand.

Lawrence Summers, former US Treasury Secretary, said there was an 80% chance that the US economy would fall into recession next year. I agree with him and would add that the whole world will also go into recession. However, Thailand could face an economic recession sooner and even worse than other countries due to the Bank of Thailand’s easy money policy and government’s distorted price controls.

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