Geopolitical risk and inflation

It has recorded the highest price increase since the 1970s and is slowly driven by inflation, disposable income, growth and jobs. This supply shock came at a time when inflation was already soaring as a result of the economy’s resurgence following the general lockdowns in 2020, and the challenges facing the transport system and distribution system are facing challenges. the sudden recovery in demand and the change in consumption patterns supported by the pandemic. Events resulting from Covid-19 and the occupation of Ukraine highlighted the fragility of logistics networks and their inability to adapt to changes.

On the other hand, monetary policy is caught at a crossroads, between the urgency of response and the need for correction, preventing the response from thwarting increasingly fragile growth prospects. From the discussion of the optimal moment for stimulus withdrawal, there has been a debate as to whether reference rates should be increased less or less.

In this context, the re-emergence of geopolitical risk brings additional uncertainty to the consumption and investment decisions of the actors. And inflation, which seems less temporary as the months go by, is fueling this uncertainty, both by lowering the real value of money and by the monetary policy decisions it envisions. Currently, the CPI easily exceeds estimates in countries such as Spain, Germany, Italy or France… And it is the underlying component of the food price behavior and inflationary process (without energy or unprocessed food) in almost all countries.

The behavior of prices in the Eurozone has been frankly negative throughout May, with an average increase of 0.8%, which, if sustained at this rate (which doesn’t sound easy but at this point, we can’t ignore it) would lead us to 10% annual growth. This acceleration in prices, which spreads to all sectors of the economy, creates a serious discomfort in the decision-making process of economic units, which make long-term decisions and are more reluctant to take risks. It is easy to foresee a gradual rise in the position of members of the ECB, who are more likely to take tougher measures, as long as inflation continues to be ‘astonishing’, that is, to higher-than-expected levels. It seeks to soften its impact on economic activity, to the detriment of those who think it should be more gradual.

Parallel to this remarkable increase in inflation, it is observed that wage increases have started to increase in the Euro Zone due to the lack of workers in some sectors (especially in northern European countries). Thus, in the first quarter of 2022, an increase of 2.8%, which is the highest level in thirteen years, and almost double the previous quarter was achieved. For example, in Germany or Belgium, wages are already rising by more than 4%, which, while desirable to avoid loss of purchasing power, raises fears of a price spiral. The rise in the cost of labor leads to new increases in wages and prices and new losses in purchasing power, which feeds back the rise in inflation (since the rise in workers’ wages will always be insufficient to offset the price increase).

Some recent research by the Bank for International Settlements, the European Central Bank, or the United States Institute of Economic Policy in Basel shows that companies’ profit margins do not partially meet the cost increase, or even increase. It is growing in some sectors, taking advantage of the supply challenges arising from the factors we were initially exposed to. In this context, that is, in the absence of a broad agreement to share efforts and costs (the “revenue agreement”), inflationary pressures will be greater and the monetary policy response will be stronger with, predictably, worse consequences. economic activity and employment.