Why are commodity prices rising and what is its impact on inflation?

The rise in the prices in any economy gets one and all unnerved – from the government to the masses. Price rises bring down the purchasing power parity of the buyer. Simply put, it makes common man poorer in the real terms – he can now buy lesser things with the same income he had a year back.

This is prone to make the common man angry and frustrated with the government – for not being able to make sure their income matches their spending. It stokes the feeling of betrayal in the middle-class – a politically sensitive fence-sitting voter-base that every government goes an extra mile to appease.

And this scare of inflation is back. Inflation across the world is hitting the highest levels in almost 13 years – and way above the comfort zones of the central bankers. The problem gets magnified when retail inflation spikes – because it directly impacts the purchasing power of the common man. In the US, and many other countries, retail inflation has shot up to 13-year high. In China too, the factory-gate inflation is at 13-year high.

This is the reason why the US Federal Reserve has swung into action and advanced its rate hike plan to two hikes by 2023.  Similarly, China announced a plan to release the reserves of key metals with them, according to reports. The officials in the country have been constantly warning about speculation in financial markets – and the move to release the reserves is seen as step to counter them.

But why is China cracking down on commodities for inflation?

Though the markets, which have always been rooting for lowest possible interest rates, will argue that rise in commodity prices will have the least impact on inflation, but that is like living in a parallel world. It is true that consumer inflation figures are based on the prices consumers pay for the things they buy directly. Also, consumers never buy commodities directly. But the devil is in the details and most of the things that a common consumer buys directly have these commodities used as the raw material. Hence, when the prices of commodities increase, the costs of goods sold to the seller jumps. In the normal circumstances, the seller, or the manufacturer, may even think of absorbing these shocks, thinking that they are temporary in nature. However, it is beyond thought that when the seller is trying to struggle his or her way out of the recession, any hit of such nature many send his financials for a toss. So, in the current scenario, it is highly likely that the sellers will let the burden percolate to consumers. And that is why we are seeing retail inflation also picking up across economies.

So, why are the commodity prices increasing?

Interestingly, before China swung into course correction, it had already spoilt the party. China is a crucial source of supply and demand for raw materials. It played a big role in commodity hike, as the government tried to reduce production of key metals like steel and aluminum. This caused a supply-demand mismatch – contributing to the rise in the prices. On the other side, global economic recovery has accelerated the demand for raw materials. As economies are heating up, the commodity prices are also soaring up – that has become one of the most important catalysts in the recent price surge.

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