Hike rates

High inflation forcing central banks to cut rates early and raise rates

Columnists

High inflation forcing central banks to cut rates early and raise rates


Summary

  • This economic environment is the perfect recipe for high inflation and global economies are starting to feel the strain on household and business budgets.
  • In the United States, the inflation rate for November is 6.8%, making it the biggest increase since 1982.
  • Two factors contribute to high consumer prices in retail, education, housing, entertainment, medical care, communications, transportation, among other sectors.

Investors in global financial markets pay attention to monetary policies and interest rates because 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 comprised of low interest rates, relatively high quantitative easing programs and massive fiscal stimulus programs designed to create an environment conducive to a V-shaped economic recovery from the Covid-19 pandemic. .

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

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

In the United States, the inflation rate for November is 6.8%, making it the largest increase since 1982. This comes at a time when the federal funds rate is between 0.1 % and 0.25%.

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

The Eurozone, UK, Switzerland, Australia and New Zealand are also experiencing similar economic characteristics. Low interest rates, massive quantitative easing programs and rising inflation rates.

So what causes high inflation rates?

Two factors contribute to high consumer prices in retail, education, housing, entertainment, medical care, communications, transportation, among other sectors.

First, we have abnormal pressure resulting from cost inflation. Oil prices rose 68% in 2021 before erasing gains to the current 44%. Oil is a major factor of production in the world and an increase in the price of oil increases the cost of manufactured goods, therefore retail prices.

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

Unemployment rates have fallen significantly in major economies, forcing wages to rise. In the United States, there is a current trend in the job market called “the great quit”. It’s a trend where people quit low-paying jobs while looking for better-paying jobs with better working conditions, like working from home.

Since labor is a major factor of production, organizations are forced to raise the prices of their products to afford higher wages. This trend extends to European and Asian countries.

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

The effect of lower central bank interest rates to record lows has increased the appetite for debt. This increased the money supply thereby increasing inflation. In Kenya, the additional steps taken by the President to suspend the CRB list of loan accounts below KES 5 million have increased access to loans and could lead to higher inflation in the short term.

Quantitative easing and fiscal stimulus packages have increased the money supply and boosted business and consumer confidence. This led to an increase in the money supply and inflation rates.

How does high inflation affect you?

High inflation means that your money is buying less today compared to the same amount at the same time last year. For high-income people, this may not be so important. However, for people on low incomes, it significantly hurts their budget.

For example, a surviving household with a monthly income of KES 20,000 at an annual inflation rate of 5.80% will only be able to buy (100% – 5.80%) = 94.20% of what they bought at the same period last year. This means they have to do extra work to maintain the same quality of life.

If they don’t get such a job opportunity or a pay raise, they may be forced to forego certain expenses such as health insurance or simply reduce their quality of life just to survive.

For people with excess income, 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 by increasing consumer prices. In the book, you’ll get the same amount of money, but it’ll buy less stuff.

To protect households from the negative effects of high inflation, central banks could be forced to reduce the essence of quantitative easing programs and raise interest rates to reduce the money supply, and therefore inflation.

South Africa, Mexico, Australia, Switzerland and the UK may be leading this race, but all other central banks could be forced to do the same in 2022. This will be very helpful to calm the hot real estate markets of developed countries. as well as rising consumer prices.

Rufas Kamau, Research and Markets Analyst, Scope Markets Kenya