Donald Trump would do central banks a great service if he managed to lower commodity prices.
In a recent bulletin from the Bank for International Settlements (BIS), the institution notes that the transmission of commodity price shocks to inflation could become increasingly significant. Natural gas prices remain well above pre-pandemic levels, which inevitably impacts by-products such as fertilizers and electricity. The same goes for oil prices, as the trade disruption caused by the war in Ukraine continues.
According to the BIS, fighting inflation requires different monetary policy analyses and tools depending on whether inflation is driven by demand or supply. When rising prices for goods and services are demand-driven, inflation is both broad-based and underlying, stimulating industrial production. However, if price increases reflect a contraction in the supply of commodities, the risk of stagflation emerges.
The empirical analysis from the Basel-based institution also highlights that when inflation is already high, fluctuations in commodity prices—especially energy price shocks—have a greater inflationary impact. This applies to both core inflation and inflation expectations. “As a result, major energy price shocks, occurring when inflation was already high, created an explosive combination that tested the low-inflation regimes of developed economies,” BIS experts note.
The problem is that central banks in developed countries tend to overlook commodity price fluctuations due to their often temporary nature. In contrast, central banks in emerging markets, where inflation expectations are less well-anchored, react much more quickly. However, increasing geopolitical disruptions, the difficult transition to green energy, and the fragmentation of production hubs due to the retreat of globalization are all factors that could heighten and make commodity price fluctuations more frequent in the future.
“If commodity price variations were to become more significant and persistent, central banks would need to exercise particular caution in assessing their inflationary effects,” the BIS recommends. However, it does not suggest a greater tolerance for commodity price spikes, such as by raising the inflation target or setting a higher upper limit within a target range. Such measures would undermine central banks' credibility and public confidence in their ability to maintain price stability.
“This reflection also raises questions about less radical proposals, such as placing greater emphasis on core inflation rather than headline inflation,” conclude the BIS experts. However, these considerations were published before the inauguration of the U.S. president on January 20. Well before his speech at the Davos Forum, where he pledged to push for interest rate cuts in the short term.
More importantly, he stated that he would request the Organization of the Petroleum Exporting Countries (OPEC) to increase production, declaring that “oil prices remain too high.” The decline in oil prices could further intensify in the U.S., where Donald Trump has promised to multiply drilling permits. “Trump’s call for lower oil prices will naturally be welcomed by consumers and businesses but met with skepticism by the U.S. oil industry and other global suppliers,” said Clay Seigle, a senior research fellow in energy security at the Center for Strategic and International Studies, as quoted by Reuters.
Meanwhile, David Kelly, Chief Global Strategist at J.P. Morgan Asset Management, believes that the anticipated end of the war in Ukraine could prevent the persistent rise in energy prices that the BIS seems to fear. The end of the war would allow Russia to return to more normal oil production and distribution. “Furthermore, uncertainty surrounding U.S. policy is already impacting the Fed’s decision-making,” adds David Kelly in his Note of The Week Ahead from January 13. He recalls that the minutes of the December FOMC meeting already indicated that “the current high level of uncertainty made it appropriate for the Committee to take a gradual approach toward a neutral policy stance.”
Finally, in their weekly analysis THINK Ahead, ING economists also argue that the new administration makes any significant change in approach to inflation risks less viable. “The good news for central banks—if it can be called good news—is that economic data largely suggests that they should steer monetary policy in the same direction Trump is likely to demand anyway,” ING experts explain.
In the U.S., the economy remains resilient. Inflation data, even considering December figures, remains stable. “It is therefore much easier for the Fed to justify a prolonged pause while awaiting further clarity on Trump’s agenda,” ING continues. The firm also notes that in the commodities sector itself, there appears to be a major shift in sentiment.
Indeed, oil prices saw their first weekly decline of the year (week of January 20-24), with ICE Brent falling more than 2.8% over that period. “The tariff issue has become an increasing concern for the market, particularly after the Trump administration imposed 25% tariffs on Colombia, which are expected to rise to 50% in a week after Colombia refused entry to two U.S. military planes attempting to deport illegal immigrants.”