Inflation has been a hot topic over the last couple of years as it has been on the increase since 2021. We all feel the effect of this constantly increasing inflation very directly in our day-to-day lives and it has sparked concerns and discussions among economists and other financial experts. In this article we will unpack what has been some of the main contributing factors that have led to our current inflation situation over the last few years, to help you have a more informed opinion about the situation.
Factors that Stemmed from the Covid Pandemic:
Although these factors are no longer the main driving forces behind current inflation, it is important to understand them as they were the initial driving forces that initiated the inflation surge that started in 2021.
Higher Money Supply During and After the Lockdowns
During the 2020 lockdowns, reserve banks and governments acted quickly to try and prevent an economic standstill. Interest rates were lowered to near-record levels while governments generously made stimulation packages available to businesses and individuals. Money supply should be thought of as a wave that increases and decreases over time and is not something that can be managed with precision in an economy. The result was that although this increase in money, which led to increased disposable income for many in the economy, did help aid struggling economies at the time of the lockdowns, it did ultimately lead to increasing consumer activity as the world started to come out of lockdowns. This increased demand was a main driver during the initial inflation surge.
Supply Chain Disruptions
While, on the one hand, demand increased due to consumers having access to higher disposal income, the supply of goods and services was slower to recover following the lockdowns, which added to the inflation pressure. Many industries such as aviation and construction were seriously affected by the lockdowns, causing a rippling effect on most other sectors and industries. Small businesses, in particular, that did not have the necessary capital reserves to manage the liquidity shortage during lockdowns had to close their doors which lead to further supply constraints. China’s lockdown policies, which were enforced until late 2022, were a serious contributing factor to many industries not getting access to manufacturing parts and goods for extended periods further harming the supply of goods and causing price increases.
Other Factors that Lead to Global Inflation:
International Conflict and Tension
The war between Russia and Ukraine undeniably played a key role in driving up inflation over the last few months. Not only did wheat prices increase globally, given that Ukraine is an important exporter of this important commodity, but international sanctions between the East and the West have fuelled the already blazing inflation fire. Although now somewhat contained, this war also led to the energy crisis in Europe as they were highly dependent on natural gas from Russia. Initially, the cost of energy prices increased steadily following the start of the war, but Europe has been able to successfully diversify its gas imports.
A more recent development which is adding concern for the inflation situation is the disruption of shipping in the Red Sea, caused by assaults by Yemen’s Iran-backed Houthi militants. The Red Sea is a very important trading route if this escalates it could cause another serious global supply issue that will ultimately cause more inflation pressure.
Labour Market Dynamics
The labour market plays a pivotal role in inflation dynamics. Wage pressures, particularly in industries facing labour shortages, have contributed to rising production costs. As businesses compete for a limited pool of skilled workers, they often increase wages to attract and retain talent. These higher labour costs are frequently passed on to consumers in the form of elevated prices for goods and services.
Another interesting dynamic adding to wage inflation is due to the increase in what is known as “counter-urbanisation,” which is when people move from urban areas to rural areas. There are a few factors that have been contributing to this phenomenon, but an important one is that the cost of living in cities is no longer justifying the lifestyle. Remote working is also a factor that has been contributing to families moving away from the city causing available labour in cities to be decreasing. All this is adding pressure on wage inflation which is eventually carried over to the consumer.
Local Factors:
Deteriorating Infrastructure
The crumbling infrastructure at our power stations which is leading to near-daily power outages is having a widespread impact on inflation. Most businesses could not operate during such power outages and those that could afford alternative energy solutions had to invest enormous amounts of capital to buy generators and solar panels, which are ultimately passed on to the consumers as profit margins are already spread thin.
South African ports are the newest infrastructure nightmare that is threatening to add to the already severe inflation situation locally. Continued congestion at South African ports is causing delays for imports and exports. These delays have severe knock-on effects damaging the supply of goods which will ultimately lead to price increases.
Currency Depreciation
The rand has been depreciating steadily for many years and it seems like the trend will continue. Many factors contribute to the rand losing value against other major currencies, but increased risk locally is probably the biggest factor. With economic growth remaining sluggish rating agencies are suspecting a credit rating downgrade in 2024 which will see foreign investors moving their capital elsewhere. Since South Africa is a net importer, the most important being Brent crude oil, our imports will be getting more and more expensive as the rand depreciates having serious implications for local inflation outlooks.
It is clear that many factors that have contributed to inflation since 2021 have mostly started to ease, but clearly, there are still a few factors to remain cautious about. Trying to predict inflation, and with it how interest rates will be adjusted, is anyone’s guess, but the reality is still that it impacts us all directly. It is therefore always wise to understand how we got here and what lies ahead to make informed decisions with regard to your finances.
