The impact on inflation of a commodity super cycle
|In this publication we look at three commodity price scenarios and what it means for headline inflation in the US and the euro area.
In our baseline scenario, US headline inflation peaked in May while euro inflation does not top out until September. In this scenario, the rise in inflation is transitory. In a ‘commodity super cycle’ scenario, the rise in G2 inflation becomes more sustained and stays above 3% on average in 2022.
Although developments in core inflation will be key for central bank policy, a peak in headline inflation has historically eased inflation fears in bond markets.
A scenario analysis on commodity prices and inflation
Commodity prices are a key driver for headline inflation and also an important input for core inflation. Over the past year, commodity prices have surged and oil prices are now back to pre-crisis levels while metal prices and food prices are close to 50% and 30% higher than pre-crisis levels, respectively. These sharp rises have raised the question of the inflationary impact with some (such as the Federal Reserve), arguing the impact will only be temporary as commodity price inflation comes down, while others project a super cycle in commodity prices due to the strong growth in the global economy amid unprecedented fiscal and monetary stimulus as well as the lifting of restrictions.
To get a sense of what is needed to see a sustained rise in inflation rather than a transitory increase we have drawn up three scenarios for commodity prices and looked at the impact on inflation. As the analysis focuses on upside risks to inflation, we have chosen to only look at scenarios that imply higher prices than what we have in our baseline. Of course, another scenario could be that commodity prices starts to decline at some point. This would imply a sharp drop in headline inflation next year.
As it is only a partial analysis we do not look at other drivers than commodities, and the scenarios are chosen for illustrative purposes (see more in the box on page 3). Equally important for whether the inflation increase is sustained or transitory will be the spill-over into core components of inflation, wage growth and how tight the labour market is. We will look more into these drivers of core inflation in our next paper in this inflation series.
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