Consumers are hard hit, but businesses do not keep up. Probably hardly every Latvian has heard anything about the salt or buckwheat boom, when for one reason or another everyone rushed to empty the shelves, but the goods were in stock as much as they were, because it is impossible to plan the hustle, but excess stocks are detrimental to business.
With constant supply and growing demand, the resulting rise in prices was logical. At the moment, everyone is seeing or waiting for an increase in demand, they can prepare for it, but everyone wants to prepare at the same time.
The good news is that there is progress in the fight against the virus. The global average number of new infections per week has been declining for a few months now(Figure 1) and vaccination rates are also rising worldwide.
Progress in the fight against the virus has allowed governments to reduce or even lift restrictions. This means that the intensity of population movement is increasing, which also brings with it an increase in demand for products and services. Statistics show that there are products and services that work well in the digital environment, but which, until the opportunity arises, people want to use in person. We see this, for example, in the DIY segment.
A simple example of how more active mobility affects demand and prices is the fuel market. It should be noted that there are many factors influencing the fuel market (from political decisions on oil extraction and import/export, to terrorist and hacker attacks on oil pipelines and even weather in the Gulf of Mexico).
But putting aside a lot of other variables, the more we drive, the greater the demand for fuel (as long as everyone does not have an electric car) and consequently fuel prices are pushed up.
Oil prices have risen sharply since reaching record low levels in April last year, when US crude oil futures prices reached as high as USD-40 a barrel (and that's not a dash). The price of crude oil has risen by almost 40% since the beginning of the year. In a large number of products and services, the price of transport (fuel) is an important factor influencing the final price of a product or service. As a result, fuel prices play a key role in inflation (Figure 2).
After lifting the restrictions, there has been a huge increase in demand, which poses challenges on the supply side, congestion in supply chains, problems with staff availability and, in addition, contributes to sharp price rises that will not be sustained if supply chain congestion diminishes and demand weakens (because the effect of government lump sum benefits will also not be long-lasting).
Unemployment is declining, in the United States it is declining rapidly, and in the euro area it is slower, as there are also differences in the accounting of unemployed and downtime allowance recipients (Figure 3). But even as unemployment falls, it remains high. Paradoxically, there are already cries for help for employees from entrepreneurs (article in the Financial Times "We need people": Berlin’s grand reopening hit by labour shortages).
The situation in the labor market is also one big unknown that affects and will affect inflation. An important factor to look at is wage trends. Segmented staff shortages can lead to higher wages, higher prices for segmented products and services, and can support sustained increases in inflation.
ECB considers this risk to be low for the time being, as the services sector in the euro area is still in the process of recovering from restrictions, which means potential labor availability (although the Berlin hospitality industry does not already agree - FT article).
Will this pressure on prices lead to higher interest rates and higher credit prices? If we are talking about the euro area, then no. The ECB has always been “slower” in its conduct than the US FRS (Figure 4).
Last August, the US FRS introduced a change in its monetary policy wording regarding inflation, which reads: "we will seek to achieve inflation that averages 2 percent over time." This means that the US FRS will not follow every significant change in inflation but will assess inflation behavior over the longer period of time.
The ECB will do the same. The latest ECB inflation forecasts (Figure 5) currently indicate that inflation is not expected to remain high. In fact, the ECB believes that inflation will not even reach the ECB's target of close to 2% over the next few years. It also means that short-term interest rates have no reason to climb and this is also reflected in the interest rate tables.
Another story is about long-term interest rates, which have risen in response to rising inflation (Figure 6). Of course, time will tell if there is a reason to be cautious. If the ECB makes mistakes in its forecasts and the inflation jump is higher and longer than expected, short-term interest rates may rise and long-term interest rates will be even higher, as they usually outpace reality in short-term and inflation rates - sometimes the market situation development is guessed, but sometimes the mistake is made.
The main issue that companies need to address in terms of interest rate expenses is: to fix interest costs in the long run or not in the long run. This should be done in the context of market developments, but more so in its risk management policy, as no one will ever accurately guess future interest rate behavior.
If the decision is to fix interest rate costs, then the question is about the period and type (fixed rate loans or floating rate loans plus interest rate swaps (IRS) for a specific loan portfolio volume) and at what levels long-term interest rates are located. This decision can also be based on the level of long-term interest rates in relation to budgeted expenditure over the next x years and the difference between short-term and long-term interest rates.
If the decision is not to fix interest rates, then we can only hope that inflation will actually rise according to forecasts (but short-term rates will not change significantly) and then when the effects of lump-sum benefits disappear, inflation will fall and rates will remain low. What is your plan?
