The Global Inflation Crisis: What Will It Cost Your Business?

In the session, The Rise of Global Inflation Crisis: At What Cost to Your Business? Carsten Brzeski answers burning questions on the short-term and long-term effects of inflation on businesses, which industries will inflation hit the hardest, whether a recession is around the corner, and more.  

   

What are the short-term and long-term effects of inflation on businesses and consumers?

Costs are increasing — energy, commodities, food, and input prices. If your cost position goes up, you will feel it as a business. If you’re in services, you will see the long-term effects in terms of wages. If you’re in manufacturing, you will feel it in input goods. Interestingly, in Europe, at least until this summer, businesses were able to pass most of their costs to other businesses or consumers. There was so much demand and people were buying everything they could.  

However, we have seen a turning point, prices have increased too much that buying something has become unaffordable. Businesses can’t buy input goods at this extremely high price because they can no longer sell them. We even have anecdotal evidence of production facilities closing because costs have increased. Inflation is clearly affecting businesses in different sectors.  

I think Europe is sliding into a recession because these costs can no longer be passed to consumers. High energy and commodity prices are here to stay, maybe not exactly at the same level as they’re currently, but they will be higher than before the war. The war in Ukraine is more of an economic game changer than two years of COVID have ever been.

What should not be underestimated is the possible shifts in the global economy — moving away from just-in-time delivery towards new supply chains and the end of globalization as we know it. A world that is dominated by more regional trade agreements. In this case, companies will have to restructure the production and processes of supply chains, and this comes with higher costs.   

During the stagflation crisis in the 1970s, there was the so-called price wave spiral: inflation goes up, wage growth goes up, and inflation increases again. Soon we will see higher wages as compensation for the loss of purchasing power in employees. Most of the western world, especially Europe, has an aging population. This results in a shrinking labor force and with inflationary pressure, we will see employees have more power to ask for higher wages.  

Unless you’re able to completely optimize or digitize labor, businesses must prepare for higher labor costs. My advice to employers is to invest in your workplace to make it an attractive place for people to stay and be open to innovation. The younger generation also values work-life balance so that has to be part of the job package.  

 

Besides oil and gas, which industries are most impacted by inflation?

Industries that are energy intensive such as chemical, automotive, and manufacturing. Energy has become expensive, which means businesses need to start or continue the transition to greener alternatives.    

All sectors will eventually be hit with inflation. The services sector will not be hit initially because it is less exposed to direct energy costs, but it will face the loss of purchasing power by consumers. While most sectors felt the heat from higher energy prices in the first half of the year, services were thriving because people were spending the money they saved during the lockdown. Let’s fast forward to the coming months when the heating season starts again. Energy bills will multiply fivefold, which will affect the services industry in the long run. 

 

How does the current economic situation compare to the stagflation crisis in the 1970s?

Other regions that are important for the global economy are not experiencing the same inflation crisis as the U.S. or Europe. The world has become much more fragmented with economic power being more spread out across the globe compared to the 1970s.  

It’s similar to the 1970s in the western world, namely higher energy prices and inflation rates. We are starting to see the difference between the U.S. and the Eurozone. In the U.S., we see the effects of higher wages which has not happened in Europe yet. Wage growth was strong in the 1970s. The happy ending would be from negative real wage growth, purchasing power declines, leading to weaker demand and lower inflation rates.  

In the 1970s, central banks were required to offer double-digit interest rate levels to kill inflation. Central banks today react faster, even the ECB. I have doubts about whether central banks can bring down inflation by changing business and consumer expectations. If they can, the recent interest rate hikes would already be sufficient to lower inflation.  

 

What actions should a business take to minimize risk during times of high inflation?

I don’t think businesses can fight inflation. Governments can lower inflation rates by introducing price caps and energy rebates. Secondly, central banks can help by hiking interest rates. Businesses cannot actively bring down inflation. They need to adapt.  

This means purchasing managers and procurement must be more efficient to save costs. When it comes to labor costs, it’s a very tough balancing act. On one side, businesses can consider a one-off wage increase to offset higher inflation. Additionally, businesses that are exposed to high energy costs can find alternatives. This can hardly be done without upfront investments which means more initial costs.  

 

Policies to reduce inflation like tighter fiscal policies and wage control have fared poorly in the past. What are your thoughts on this?

We have a supply side revenue inflation with higher energy and commodity prices. Tackling this is impossible to do in a year, but what needs to be done is finding new energy sources that are not from Russia and providing commodities that are not exposed to supply chain problems in Asia. Of course, that means tighter fiscal policies. That’s what we hear from central banks now.  

They will bring economies down on their knees by hiking interest rates, which will then lower demand and eventually inflation. It can be a painful process. We’re listening to the Fed and the ECB and on what they’re currently willing to do. Another angle with tighter fiscal policies is to support the demand side by giving subsidies which could support the economy in the short run but increase the risk of a longer period of inflation. 

 

Is the world heading into another recession? How will Europe compare to the rest of the world?

The IMF defines a global recession as global GDP growth of below 2.5%. But considering what’s going on in other countries, I do not expect a global recession. The U.S. is still going strong and there’s a good chance we might see a soft landing there. China is slowing down, but we need to see how it will deal with its Zero-COVID strategy going into winter. My assumption is China will not slip into recession. The most exposed region is Europe and I predict a winter recession. The severity of this recession will depend on how much additional fiscal stimulus we will get in the coming weeks. 

 

Will the U.S. dollar become stronger than the euro?

We will see more rate hikes by the Fed than the ECB, which will result in the further weakening of the euro. I also think the recession in Europe will be more severe than any slowdown in the U.S., which will favor the dollar. We would need to see a resolve in the Ukraine war for the euro to improve, but I do not see this realistically happening. That means the dollar will strengthen further at least up until the summer of 2023.

 

When will we see inflation rates reduce in Europe?

Government measures over the last month have blurred the inflation picture. Every time a government measure to bring down prices expires; prices will go up again and have an imminent impact on inflation. The so-called passing on of market gas prices to consumers and companies takes a while. Consumers have been hit by high prices of food, gasoline, and energy. This means inflation in Europe will still accelerate. Several countries in the Eurozone already have inflation rates above 10%.  

I think the rates will remain until Q1 2023 and then we should start seeing inflation gradually coming down. Obviously, a lot depends on the war in Ukraine and how gas prices will develop. I see the average inflation rate for 2022 coming in at around 8% and 5% in 2023.  

However, prices will remain high even if inflation goes down. I do not think there will be enough wage growth over the next two years. The loss of purchasing power will mean that Europe will lose economic wealth and international competitiveness due to higher cost pressures on the business side and high inflation on the consumer side. 

 

Are there any hidden opportunities for businesses during this economic crisis?

We have so many crises, particularly here in Europe. We are amid a perfect storm. The wild card is how will governments react. What we learned from the pandemic is that governments can cushion any economic slowdown via fiscal stimulus. Currently, Europe has an average fiscal stimulus measure of around 2% to 3% of GDP, aimed at bringing relief against high energy prices. During the pandemic, we had fiscal stimulus from European governments between 10% and 15% of GDP.  

I think the silver lining is when you get to investigate the reasons for inflation. The main reason is energy prices. Prior to the war, there was the European Green Deal initiative. This transition offers enormous business and investment opportunities for organizations. There will also be opportunities for some regions in Europe if organizations decide to reshore production processes and supply chains closer to home. In addition, financial services and fintech providers could thrive in the upcoming years as consumers want to be more efficient with their money.  

 

*The transcript has been edited for length and clarity.