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Higher commodity prices and stronger U.S. dollar increase global stagflation risk, warns BIS

Kitco News

(Kitco News) A combination of a stronger U.S. dollar and higher commodity prices, which is a departure from a historical trend, increases the risk of global stagflation, said the Bank for International Settlements.

"Higher commodity prices and dollar appreciation each increase the risk of weak growth alongside high inflation in commodity-importing economies, ie stagflation risk," BIS said in its latest quarterly report. "The combination … [is] a departure from the historical pattern, raise[s] global stagflation risk."

Emerging markets are more affected by this than developed ones, the report pointed out. "This reflects the higher commodity consumption of EMEs and their greater exposure to swings in global financial conditions," it added.

To come to this conclusion, the BIS interpreted quarterly data from 22 commodity-importing economies over the past three decades.

This is particularly important given that commodity prices have been rising in the post-COVID environment while the U.S. dollar strengthened on the back of aggressive Federal Reserve rate hikes.

"Commodity price rises tend to stoke inflation and choke off growth in commodity-importing economies, while dollar appreciation tends to have similar effects outside the United States, especially in EMEs," the report said. "Thus, the confluence of such developments over the past couple of years has significantly increased the risk of stagflation, ie that weak growth will coincide with high inflation."

Higher commodity prices lead to increases in the cost of living and production. "Inflation driven by higher commodity prices could prompt a monetary policy response that dampens the real economy," BIS said.

And since commodities are often billed in U.S. dollars, when the greenback rises, it compounds the stagflationary problem, according to the report.

The BIS added that higher commodity prices also erode the debt repayment capacity and could lead to tighter financial conditions.

"A lasting positive correlation between commodity prices and the dollar exchange rate would imply greater challenges for macro-financial stability policies going forward. It could lead to greater macroeconomic volatility and more difficult tradeoffs between inflation and output stabilization," the report concluded.

The quarterly report also said that markets should not rule out a global synchronized reversion to higher-than-expected rate levels.

"Central banks have been very clear about the priority of getting the job done and of being cautious about declaring victory too early," said Claudio Borio, head of the monetary and economic department at the BIS. "[This] cautious attitude is the appropriate one."

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