In its March 2024 policy meeting, the US Fed Chairman Jerome Powell announced that the Fed would keep its benchmark interest rate unchanged. He suggested that the US Fed is committed to bringing inflation down to the target rate of 2 per cent.

If the inflation is brought down to a satisfactory level, then the Fed may consider cutting the benchmark interest rate later this year.

Powell mentioned that given the present economic scenario, it could be assumed that the benchmark rates have reached their peak, and the prevalent high interest rates are already having some contractionary impact on the economy, especially on mortgage rates and business fixed investment.

He, however, also pointed out that the present inflation in the US is still higher than its target rate, and the US Fed is “prepared to maintain the current target range of the federal-funds rate for longer, if appropriate”. Is he being the proverbial conservative central banker? Or are there reasons to be cautious?

We believe there are reasons to be concerned with the future trajectory of inflation, and a number of factors can act as spoilsport in moderating inflation.

Commodity worries

The first worrying sign comes from commodity prices. Some of the important commodities have been showing a rising trend in prices over the past few months. These include beverages like tea, cocoa and coffee; food items like rice and sugar; agricultural raw materials like cotton and rubber; minerals and metals like crude oil and copper, etc.

Among these, the most remarkable rise has been in cocoa prices, which have more than doubled in one year and reached an all-time high.

This dramatic rise in cocoa prices has been primarily attributed to the El Niño weather phenomenon. El Niño, meaning Little Boy in Spanish, is currently associated with hotter temperatures and irregular rainfall patterns.

A recent FAO report indicates that El Niño induced drought has affected many agricultural-producing countries in Northern and Southern Africa, and there is likely to be an exceptional shortfall in aggregate food production in that part of the world.

Consequently, according to the FAO estimate, around 33 countries in Africa will face large-scale food shortages in 2024. According to the IMF, the adverse impact of El Niño will also be felt in some of the countries in South America, especially in the Andean region (Colombia, Ecuador, and Peru). It will lead to a significant loss of output in these countries. These disruptions will likely spill over into the international market and may push up prices of agricultural products.

The second important factor adding to the uncertainty surrounding global commodity prices is the heightened geopolitical tension and increased shipping cost. The IMF, in its 2024 update of World Economic Outlook, points out that “new commodity price spikes from geopolitical shocks — including continued attacks in the Red Sea — and supply disruptions or more persistent underlying inflation could prolong tight monetary conditions”.

These disturbances have also increased the shipping time and affected supplies of intermediate inputs and consumer goods worldwide. Projections by Fitch suggest that shipping costs are likely to “remain high for several quarters”.

The third factor which may impact prices is the changing attitude towards international trade policy among the political leadership in many countries.

The year 2024 is being called the global election year as 64 countries along with the EU are going to polls this year. These countries and regions account for around 49 per cent of the global population. In most of these countries, this is the first major poll since the pandemic.

As the political rhetoric has shifted from hyper-globalisation to self-sufficiency sparking fears of geo-economic fragmentation, the world is likely to expect a more defensive approach towards international trade.

Protectionist moves

In the US presidential election, the Republican party candidate announced that he would impose 60 per cent or higher tariffs on Chinese goods in his potential second term.

In addition, he proposes to impose a 10 per cent tariff on all imports. While the incumbent US President has been less vocal about tariffs, several reports suggest that his administration is also considering reinstating some of the Trump-era tariffs. Higher tariffs affect consumer prices and push up inflation.

Such protectionist trade policies adopted by major developed countries also lead to countervailing policies in many developing countries. Since the pandemic, many countries have imposed voluntary export restraints (VER) on different products to manage domestic inflation or achieve self-sufficiency. An export restriction reduces the supply of a product in global markets and, exerts upward pressure on its global prices.

A recent World Bank report mentions, “Export bans in products such as rice, wheat and citrus fruits have led to increases in prices by about 12.3 percent, 9 percent and 8.9 percent, respectively”.

The fourth factor that could potentially destabilise global commodity prices, especially the prices of metals, is the possible resurgence of China. China is the second-largest economy in the world and has suffered a significant economic slowdown and price deflation in the past year or so.

The Chinese government is expected to adopt expansionary and countercyclical economic policies to revive the economy. If demand increases in China, it will impact global commodity prices significantly. Prices of metals and crude oil will definitely react strongly to any rebound in Chinese demand.

Overall, it appears that 2024 might be a year where commodity prices could be volatile with a possible upward bias. These may translate into higher inflation and ultimately impede interest rate easing by major central banks.

We are possibly heading towards higher and more extended periods of elevated interest rates, which is not good news for the financial markets and the borrowers in general!

As some of these factors driving prices upwards are beyond the traditional toolbox of central banking, possibly more coordination between national governments and the central banks are needed to tackle this kind of inflation. And if such shocks persist, maybe central banks should think about more flexibility in an otherwise inflation targeting regime.

Pal is a Professor of Economics at IIM-Calcutta; and Ray is Director of the National Institute of Bank Management Pune. Views expressed are personal.