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The conflict in Ukraine has delivered a commodity price shock similar to that of the early 1970s, shattering hopes that the inflationary uptick may prove to be transitory. As inflation reaches multi-decade highs, we analyse what is driving inflation across the world and consider what central banks need to do to get inflation back to target levels.

As we consider how inflation will evolve in the coming months and years, it is helpful to understand past inflation cycles and how they impacted investments.

In general, there have been four primary causes of inflation, some of which overlap (see table below):

• Excess money supply growth – Too much money chasing too few goods. Money supply growth leads to more bank lending resulting in faster economic growth.
• High resource utilisation rates – Utilisation rates going persistently above 80% has been the approximate historic dividing line between rising and falling inflation in the US.
• Price shocks – Cost-push inflation may be driven by energy prices, other input price increases, supply chain disruptions or currency declines.
• Inflation expectations – Inflation can be integrated into the economic system if participants start to assume that prices will always increase, usually via wage increases and long-term contracts.

While there are sufficient differences in terms of the drivers and the market environment, it is difficult to make strong conclusions about what might happen in future periods of inflation. Inflation is complex and the drivers and effects have changed not only with each episode but also within the episode.

What does history teach us?

A brief history of inflationary episodes

1966-70 – The early/mid-1960s was a period of accelerating government spending and accelerating money supply growth, which supported rapid bank lending. This caused consumer and corporate demand to grow at more than 6% p.a. for five years and ultimately led to resource utilisation exceeding 90%.

1973-75 – The Middle Eastern energy crisis drove oil prices up 184% in 1973-74. Companies were unable to absorb such a cost increase in their profit margins, so they passed this on to consumers. Since this was a period of high unionisation, wage increases accelerated, leading to rising inflation expectations.

1978-80 – Similar to 1973-75, except that oil prices almost quadrupled during 1980.

1987-91 – Increases in resource utilisation and the declining US dollar led to inflationary pressures. The spike in oil prices around the first Gulf War caused a further increase in inflation.

1999-2001 – Resource utilisation was high (evidenced by an unemployment rate below 4%) and oil prices almost tripled.

2004-06 – Monetary policy was highly accommodative, resource utilisation rose, oil prices went up almost four times and the US dollar declined.

2010-12 – Commodity prices increased and the US dollar declined.

2021-current – Pandemic-related fiscal stimulus fuelled very strong demand which exacerbated the impact of supply-chain disruptions caused by COVID-19 lockdowns. The recent surge in commodity prices from the Russia/Ukraine conflict has amplified the acceleration in inflation that we have been seeing globally. Both Russia and Ukraine are important food commodity exporters, with Russia and Ukraine accounting for roughly 30% of the world’s wheat exports.¹ Russia is also an important exporter of nickel, palladium, and titanium.

1. As at 8 April 2022. Source: United Nations