Every morning new headline highlights growing economic concerns: Highest inflation since 1970s. Central banks are aggressively raising rates. Consumer sentiment at historic lows. Commodity prices close to all-time highs. It is clear that inflation has, at a minimum, altered the economic mood and potentially reset the trajectory of global and national economies around the world for years to come. McKinsey experts have considered many policy implications of inflation. Here, we use the best and most recent publicly available data to provide seven charts illustrating the insidious progression of inflation.
Double penalty. Over the past six months, inflation has significantly exceeded December 2021 expectations. In many countries, real rates have doubled projections. European countries are particularly affected. For example, inflation in Lithuania is running at 15.5% per year, almost five times the expected rate. Poland is at 11% and the UK at 9%, both well above forecasts. At 3%, Switzerland is an outlier. Asia is seeing a less severe change: Indian inflation is around 7%, just slightly above forecasts; and South Korea is at 5%. In China and Japan, inflation remains subdued.
Here is the cavalry. In response to the alarming rise in inflation, central banks around the world are raising their key bank rates. So far, however, rate hikes in most countries have not kept pace with inflation.
As we will discuss next, rising rates should ease demand and lower prices for two key components of headline inflation: housing and commodities such as energy and metals.
Safe as houses? House prices rose sharply even before the wave of inflation in 2022, as the pandemic prompted a massive housing shake-up. Here we show the rise from 2020 to 2021. House prices have climbed far beyond expectations in a fairly global phenomenon. In Europe, Turkish owners recorded the largest gains, followed closely by those in the Czech Republic and Lithuania. In Asia-Pacific, New Zealand and Australia recorded strong gains. In North America, the United States and Canada both benefited from the push; Mexico did not. In Colombia, one of three Organization for Economic Co-operation and Development (OECD) countries in South America, gains were weak.
Contribution of raw materials. Investors often say that in times of inflation the best place to invest is in commodities. This is of course because commodity prices reflect the demand for commodities needed for economic expansion. The pattern is true for most of the commodities in this exhibit: as the economic stimulus revived the global economy that had been dogged by the COVID-19 pandemic, prices took off. Then the invasion of Russia drove prices up even further. The biggest increase is in fertilizers. Boosted by shortages of natural gas, a key ingredient in fertilizer manufacturing, and growing demand from farmers, fertilizer prices have risen sharply.
A smoldering food crisis. Soaring fertilizer prices, along with other fallout from the war in Ukraine, have pushed staple food prices much higher. Since 2021, food prices have reached their highest level since the United Nations Food and Agriculture Office launched its index. Prices are now considerably higher than during past spikes in 2008 and 2011, which were precipitated by the turmoil of the global financial crisis. Over the ensuing decade, prices moderated considerably. But they have risen sharply in 2021, with supply chain issues, drought and other forces at work. And the war in Ukraine has taken food prices to a whole new level.
Wage erosion. From the components of inflation, we now turn to two of its most critical effects on the global economy, beginning with wages. Real wages had stagnated for many years in the largest OECD economies. Just before the pandemic, real wages rose sharply; tightening labor markets have given workers the advantage in negotiations. The pandemic has radically changed the equation, of course.
As economies stabilized and rebounded, real wages began to climb again. But rampant inflation has dampened this growth, rising so rapidly that it has diminished the purchasing power of people’s take-home pay. For example, workers in the UK today saw their real earnings fall by around 8% year-on-year.
A darkening of growth prospects. With prices soaring and showing few signs of abating, the risk is that inflation takes hold and central banks are forced to raise rates with more confidence to dampen demand. As a result, many analysts are lowering their economic growth projections. For example, in the OECD Economic Outlook, projected real GDP growth in Turkey is now about eight percentage points lower than previous projections; and Argentina is about the same. Projections for the UK are now 7.4 percentage points lower. However, with strong demand for oil, Saudi Arabia’s real GDP growth projections are now about 6 percentage points higher.
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