World Bank exposes key driver of high inflation

The World Bank has shed light on a big economic challenge. The era of falling commodity prices as a buffer against inflation seems to be over. This revelation throws a spanner in the works for central banks globally, which may find their hands tied when it comes to adjusting interest rates downwards.

Commodity Price Stability and Its Implications

Over the last two years, we’ve seen commodity prices, including those for oil, gas, and wheat, plummet by 40% from mid-2022 to mid-2023, which reduced global inflation by approximately two percentage points.

However, this trend has come to a grinding halt. As of the past year, the World Bank’s index shows that prices have stabilized, effectively capping the period of deflationary influence these commodities had on the global economy.

The cessation of falling commodity prices heralds a troubling time for inflation control. Indermit Gill, the Chief Economist and Senior Vice-President of the World Bank Group, points out, “Global inflation remains undefeated.”

He elaborates that since the primary force for disinflation — declining commodity prices — has hit a wall, we might see interest rates remaining elevated longer than previously anticipated. This scenario complicates matters at a time when the global economy is particularly vulnerable, and any major energy shock could unravel the progress made in taming inflation over the last two years.

Forecasted Trends and Geopolitical Tensions

Looking forward, the World Bank doesn’t see a massive decline in commodity prices soon, according to the Financial Times. Their forecast suggests a mere 3% drop in 2024 and a 4% decrease in 2025. Despite these slight declines, commodity prices are expected to remain roughly 38% higher than the averages recorded between 2015 and the onset of the coronavirus pandemic in 2020.

This subtle downtrend in commodity prices does little to alleviate the pressures of above-target inflation, posing a continual challenge for central banks aiming to reduce interest rates. Ayhan Kose, Deputy Chief Economist at the World Bank Group, commented on the persistence of high commodity prices amidst slowing global growth.

According to Kose, we are entering a new era, reminiscent of the post-2008 global financial crisis landscape, causing a change in economic dynamics.

While most commodities are anticipated to decrease in price, albeit at a slower rate, copper prices are expected to climb. The ongoing energy transition is driving demand for copper, crucial for manufacturing electric vehicles and upgrading electrical grids.

Additionally, strong growth in global energy investments is applying further pressure on the demand side, keeping prices elevated. This scenario is further compounded by stronger-than-expected demand from China.

The Middle East Effect on Commodity Prices

The World Bank report also highlights that rising tensions in the Middle East could escalate the costs of traditionally safe-haven assets like gold, and also oil. The bank’s projections see Brent crude oil averaging $84 a barrel this year, a slight increase from last year, with a slight decrease to $79 projected for 2025. However, current trading figures show Brent crude around $88 a barrel, indicating volatile market conditions.

The potential for further conflict in the Middle East could push commodity prices even higher. Kose notes that such tensions add a premium to oil prices and result in more frequent price fluctuations. In a severe conflict scenario, oil prices could surge past $100 per barrel this year. This dramatic increase would likely boost global inflation by nearly one percentage point.