The conflict in Ukraine and high inflation are threatening the global economy with stagflation similar to that experienced in the 1970s, according to a new World Bank forecast.

The World Bank slashed its global growth outlook for the third time this year to 2.9% from 4.1% at the start of the year, pointing to a perfect storm of the ongoing coronavirus (COVID-19) pandemic and more recently the war in Ukraine that have combined to send inflation rates soaring.

“The war in Ukraine, lockdowns in China, supply-chain disruptions and the risk of stagflation are hammering growth. For many countries, recession will be hard to avoid,” World Bank President David Malpass said on his Facebook page after the bank issued a new update. “The risk of stagflation is very high.”

Global growth is expected to slump from 5.7% in 2021 to 2.9% in 2022 – significantly lower than 4.1% that was anticipated in January. It is expected to hover around that pace over 2023-24, as the war in Ukraine disrupts activity, investment and trade in the near term, pent-up demand fades, and fiscal and monetary policy accommodation is withdrawn. As a result of the damage from the pandemic and the war, the level of per capita income in developing economies this year will be nearly 5% below its pre-pandemic trend, the World Bank said.

The peak of inflation, as analysts expect, will be in the middle of this year, while high prices for fuel and food will persist further. Under these conditions, central banks will have to tighten their monetary policies, which, in turn, may lead to a slowdown in economic growth, warns the World Bank. The upshot is a destructive cycle of high inflation but low growth that is hard to break out of once it starts.

“The current juncture resembles the 1970s in three key aspects: persistent supply-side disturbances fuelling inflation, preceded by a protracted period of highly accommodative monetary policy in major advanced economies, prospects for weakening growth, and vulnerabilities that emerging market and developing economies face with respect to the monetary policy tightening that will be needed to rein in inflation,” the World Bank said.

Consumer price inflation heat map

Central bank monetary policy interest rates heat map

Real interest rates heat map

Inflation targeting

The current stagflation differs from the 1970s in many ways too, the World Bank said: the dollar is strong, in sharp contrast to its severe weakness in the 1970s; the percentage increases in commodity prices are smaller; and the balance sheets of major financial institutions are generally strong.

“More importantly, unlike the 1970s, central banks in advanced economies and many developing economies now have clear mandates for price stability, and, over the past three decades, they have established a credible track record of achieving their inflation targets,” the World Bank said in its report.

Most of the central banks of the world have followed New Zealand’s lead and adopted inflation targeting policies that are designed to give the population confidence that the regulator will manage inflation. Once it loses that grip then “unanchored” high inflation expectations are themselves inflationary.

The three heat map charts show respectively: consumer price inflation, monetary policy rates and real interest rates for countries under bne IntelliNews coverage between January 2020 and April 2022. (Click on the links or the charts to see the data.) Before drilling into the details of the data several things are immediately apparent from the charts.

Inflation was generally low across the entire region at the start of 2020 before the pandemic struck, but started to take off between the spring and summer of 2021. However, it has only really become a very noticeable problem since the start of this year and increasingly so from March onwards. As of April all of the country’s in bne IntelliNews’ patch of 30 countries have inflation rates in double digits, bar five.

The picture with central bank monetary policy rates is more mixed. In general each country that joined the EU has low rates thanks to the stabilising effect of union membership, while those outside have much higher rates. The trend here was several countries were cutting rates between the second half of 2020 and into the summer of 2021, but nearly all of them started hiking again in the autumn of that year as inflation took off around the world, largely driven by rising commodity and food prices.

Combining the consumer price inflation and central bank prime rates to get a heat map of real interest rates and the picture is clear. While most countries had positive real interest rates for most of 2020, from the spring of 2021 those rates were starting to turn negative and the gap has continued to grow in the first months of this year.

Central banks across the region have been aggressively hiking rates, but the heat map suggests that they mostly remain behind the curve and need to hike further, which is why the World Bank is warning that stagflation looms. Negative real interest rates are a precursor of stagflation.

The growth in negative real interest rates is not out of control yet. About half of the countries in the bne IntelliNews patch still have negative rates in single digits so the central banks there can redress the problem fairly easily. But in the other half with negative real rates in double digits the size of the hikes needed to fight inflation has already reached very painful levels.

A few countries are ahead of the curve and seem to have got the problem under control, with the Central Asian states and Hungary ahead of the game. Hungary is one of the few new EU countries that has already solved the problem and has positive real interest rates.

Rising inflation has been worrying central bankers for well over a year now. Central Bank of Russia (CBR) Governor Elvia Nabiullina was afraid inflation was becoming unanchored before the war in Ukraine started and ended seven years of easing to put through a series of aggressive rate hikes at the end of 2021 and early 2022. She more than doubled the rate to 20% days after the invasion of Ukraine started and successfully headed off more inflation; the inflation expectations of the population rapidly fell six percentage points in May after the hike.

Likewise, the National Bank of Ukraine (NBU) similarly just put through a massive 15% rate hike to 25% on June 2 to head off inflation and stabilise the exchange rate. Hungary has very successfully kept control of inflation after the central bank put through an aggressive 100bp hike on March 22 to hike rates to 4.4%. Hungary’s central bank acted after inflation growth went into double digits in May. the Czech central bank similarly hiked rates by 50bp on April 1 to bring the rate to 5% for the same reasons, but will clearly have to hike further.

Most countries will have to continue to hike rates during the summer. Many are currently suffering from historically high levels of inflation that are stubbornly remaining high, as bne IntelliNews regularly reports in its data section. Poland has seen an uninterrupted rise in inflation since the end of 2020. Slovakia’s inflation rate is currently at its highest level in two decades and Czechia's at its highest level since 1993.

The danger of not hiking rates is social unrest. In some of the poorer countries, the soaring cost of living has already led to riots, such as Albania has suffered from in March. The fear is that, as bne IntelliNews reported as early as January, when the food crisis caused by Ukraine’s inability to export its grain is coupled with the skyrocketing prices this social unrest will spread further afield, especially in North Africa.

In fact the only central bank that has been able to loosen monetary policy since the war started is Russia, albeit after an extreme emergency hike in February: the CBR has already cut rates three times, to 17% then 14%, both in April, and then again in May to the current 11%.

Still, Russia’s problems are specific and largely caused by sanctions, not economics. But the size of the economy – the biggest ever to be hit with such extreme sanctions – is large enough to hurt the global economy. The World Bank estimates that a two-year recession is possible, which means the Western sanctions will boomerang back and hurt everyone to some extent. Stagflation will be one of the main vectors for this pain.

“Inflation has risen sharply from mid-2020 lows, while global growth, by contrast, is moving in the opposite direction and will be lower than in the 2010s for the rest of the decade,” the bank said in its forecast.

In April 2022, global price growth amounted to 7.8% – for the world as a whole, this is the highest level since 2008, and for developed countries – since 1982, according to the World Bank. 

1970s vs 2022

All this is reminiscent of the stagflation of the 1970s, which was triggered by high oil prices, inflation, significant federal spending and loose monetary policy, the World Bank notes.

The war and persistent supply chain problems also mean production in 2023-2024 will grow at a reduced pace throughout the world. In addition, the World Bank raised its oil price forecast by a quarter – in the base scenario, the average price of a barrel of Brent in 2022 will be $100, and in the negative, with extended sanctions against Russia (this scenario is now being implemented) it will rise even higher to $140 and so further mitigate the pain of sanctions on Russia, The Bell reports.

In the 1970s inflation in developed countries went into double digits against the backdrop of falling GDP and rising unemployment. The crisis peaked in the mid-1970s, when inflation in the United States exceeded 12%, unemployment 9%, and economic growth was negative, and in the early 1980s, when inflation went beyond 14%, according to The Bell.

One of the main factors of stagflation in the 1970s was a sharp rise in prices for raw materials and especially oil after the Arab countries imposed an embargo on exports to the United States in 1973 and the Iranian revolution in 1978-9 also sent prices upward. The problems were made worse by the soft monetary policy of the world financial authorities, who after 1968 feared unemployment growth is greater than inflation, and actively printed money.

The current situation differs from the stagflation of the 1970s with a strong dollar, less dramatic increases in commodity prices and the presence of stocks on the balance sheets of large financial institutions, the World Bank said. In addition, central banks now have more tools to curb inflation than they used to.

Stagflation was ended in the 1970s after central banks finally hiked rates aggressively, but that caused a global recession that lasted several years as well as triggering several financial crises.

The lights are already flashing red. Real interest rates around the world are already deeply negative in many countries, averaging minus 5.2% for developed countries and minus 3.2% for developing countries, The Bell reports. The longer the rate hikes are delayed the more pain it will cause when they eventually are hiked.