Global economic outlook: Inflation

The world’s economies are nearing price stability. Consumer prices increased by 3.1% in the United States in November and by 3.1% in Canada as of October. In the euro area, prices increased by only 2.4% in November, well within reach of a 2% inflation target.

Prices in the UK are stickier, however, increasing by 4.6% in October and not expected to fall below 3% until the second quarter of 2024. About three-quarters of UK inflation now results from food, and hospitality and recreation.

Arguably, it would have taken a recession to quickly end the price shocks of the past two years, and we cannot expect the impact of the war in Ukraine on food and energy prices to evaporate overnight. In light of the cash sloshing around the developed economies, the downtrend in inflation is encouraging for household income and global growth.

We anticipate that the easing of inflation in the U.S., Canada and Europe will allow their central banks to pause their rate hike programs and then gradually release the brakes on economic growth over the course of 2024 and 2025.

The emerging economies, however, will still be faced with higher prices for essential needs, including food and energy, which will affect the well-being of households.

The price of essentials

There is a difference between the concept of inflation and the persistence of high prices of essential products.

We characterize food and housing as essential products, with neither having realistic substitutes.

For example, while a consumer can choose to take public transportation rather than pay high gasoline prices to drive a car, there is no substitute for feeding or providing shelter for a family.

Food prices, according to the foodstuffs index of the Commodity Research Bureau (CRB), peaked in May 2021 after increasing by 78% from January 2020. The index has dropped by 15% since then, and using December 2022 as the base, food inflation in December 2023 dropped below zero.

But households continue to use a larger portion of their income for food. 

It would be easy to blame the rise in food prices on the war in Ukraine, the breadbasket of Europe. And yes, the CRB foodstuffs index spiked by 10% in the months after the February 2022 invasion. But food prices were already 60% higher than in January 2021.

A recent study by the European Central Bank (ECB) found that climate change poses risk to price stability. For instance, the study estimated that the 2022 summer heat extremes increased food inflation in Europe by upward of a percentage point.

The paper notes that research on the impact of climate change on inflation is in its infancy. Still, various studies since 2018 align with the ECB’s finding of persistent and significant nonlinear impacts of increasing average temperatures on food prices in both higher- and lower-income countries.

In the short run, Ukraine has been able to reestablish its shipping lanes.

In the long run, and in our view, the nonlinear impact of higher temperatures cited by the ECB is a clarion call for nations to continue their commitment to reducing carbon emissions. In the meantime, the developed economies can continue to help feed the world.

Global housing

The pandemic brought a spike in the demand for more space and a stampede from the city. At the same time, extremely low interest rates around the world have allowed sellers to jack up home prices in demand-driven bidding wars.

The result has been a 10% increase in the ratio of housing prices to income on a global scale since December 2019, before the pandemic.

What can be done?

Interest rates will remain high for a short period but will not return to zero unless there is another shock. That should maintain downward pressure on demand after prices peaked compared to income in early 2022.

Local demographic factors such as an aging population and a resurgence in the demand for city living as the pandemic fades may also come into play, as fewer people seek out single-family homes to purchase. Working against that are the reports of young people who are unable to afford housing and still live with their parents. In the long run, they will only add to demand when they eventually move out.

Global oil prices

The U.S. has become the largest producer of crude oil. But energy supply and prices are held hostage by OPEC, whose self-interest includes some combination of geopolitical power and control of market share.

That’s not to say that demand does not influence prices. The prime example was the 2020 drop in demand for oil during the pandemic shutdown that caused the price of Brent crude oil to fall by 50%. Brent oil prices then increased rapidly when demand resurfaced and supplies could not keep up.

The next spike occurred in May 2022 as Russian supplies of energy were cut off and before demand in the West could adapt to other sources.

Europe's response to the energy cutoff is an indication that modern societies can reduce their use of fossil fuels. The end result will be reduced expenditures on oil and gas or, at the least, reduced price volatility.

Nevertheless, an unexpected event in the latter part of 2023 was the near 25% decline in the price of oil globally. Rising oil production out of the U.S., Brazil, Norway and Guyana has created a modest surplus in global markets as demand in Europe and China has eased.

At some point, Saudi Arabia, the major swing producer inside the cartel, will have to either accept a much lower price than it prefers or flush the market to greatly lower the price.