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Problems Prolonged

26 April 2022

When will it all end? The world seems to lurch from one problem to the next. We thought we had Covid related concerns beaten but we didn’t factor in the Chinese government’s zeal to stamp out the virus completely rather than learn to live with it like the rest of the world. Rolling lock-downs of major Chinese cities and ports are once again causing havoc with supply chains of every description, thereby adding more fuel to the inflation flames. One possible silver lining is that the resulting likelihood of Chinese recession has taken the heat out of the (still very high) oil price, but for how long is anybody’s guess with Europe still only thinking of how to avoid Russian energy supplies.

And as Russia endeavours to lay siege to large swathes of Ukraine, the world’s dependency on the region for wheat, sunflower oil and potash for fertilisers is driving the price of those products higher. What started as a “transitory” burst of Covid induced inflation is turning into anything but. In the face of this the US Federal Reserve and the Bank of England’s Monetary Policy Committee have been lining up interest rate rises (the traditional weapon of choice against inflation) for the rest of this year and beyond. But the question has to be asked – is this the correct response in these circumstances?

When inflation is rising as a result of a booming economy it has to be tackled by slowing down the economic growth and that is usually achieved by raising interest rates. That is clearly not the case here. Economies had a brief boomlet as we threw off the Covid shackles but that was already beginning to wane when Putin launched his brazen offensive against Ukraine. Will raising interest rates cure the spike in the prices of oil, gas, wheat, sunflower oil and fertiliser created by this conflict? It will not, at least not without killing the economy completely – something western governments are desperate to avoid. And if the war turns out to be even more prolonged then the problem will only get worse.

Then we have the rerun of the Chinese lockdowns, driving prices of all manner of products higher as supply chains are interrupted. This will surely result in the manufacture of products and parts being brought home or nearer to home but that will take time. Meanwhile shortages are driving prices higher. Will raising interest rates resolve this without killing the economy? It will not.

Monetarists have pointed to the rapid decline in money supply, both here and in the US, over recent months. In the past this has been a pretty good pointer to economic slowdown so it probably points to the inflation remedy already naturally being underway. With this in mind the central banks really need to be very careful about the use of interest rate rises on top, particularly in the UK, where Rishi Sunak’s tax rises have also to be absorbed. Markets are likely to face a very uncertain few months as those central bank plans evolve. It seems sensible for all portfolios to keep some powder dry.

 

Russell Dobbs FCSI

Chartered Wealth Manager