The effect of inflation on investment returns

The effects of the supply chain disruptions experienced since the onset of the Covid-19 pandemic and the ongoing crisis in the Ukraine have sent the prices of various goods soaring. The most notable effect since the start of the Ukrainian conflict has been the sharp increase in oil and grain prices.

Both Russia and Ukraine are major exporters of agricultural commodities, most notably wheat, the price of which has increased by over 53% since the outbreak of the conflict. Russia is also a major player in the energy market, being the world’s second-biggest producer of both oil and natural gas.

The rapid increases in food and oil prices, and by association fuel, have raised headline inflation significantly across the globe as well as in South Africa. Indeed, the margin between headline and core CPI has widened markedly, with the food and non-alcoholic beverages and transport being the main subcategories showing substantial differences between the two measures of price changes.

Headline inflation last month came in at 5.9% year-on-year, unchanged from the previous month, and only 10 basis points below the upper end of the SARB’s target band of 3-6%. This figure was dominated by food price inflation rising 0.8% from the previous month, and transport costs rising by 0.2% over the same period. Transport price increases, however, were muted due to the National Treasury providing relief by cutting the fuel levy by R1.50, a consession that is set to expire.

There is a risk that inflation could spike higher this year and breach the South African Reserve Bank’s (SARB) upper limit of 6%. A notable risk is the second-round effects of increased oil prices. Oil is a major input in the fertilizer manufacturing process and consequently could propel food prices even further. Higher oil prices also increase the cost of transportation of goods, which companies could pass on to consumers. This, in turn, raises the risk of core inflation printing even higher over the coming periods.

The effect of these price increases has pushed headline inflation in most countries to crisis levels not seen in recent history. These pressures enhance the need for expert financial advice and asset management.