The inflation risk in the Gulf Co-operation Council (GCC) is low, despite surging food costs, according to Oxford Economics.
Rising global food and shipping prices have rekindled concerns of an inflation spike in the GCC but "we think these worries are misplaced", it said in a research briefing.
The region would continue to import inflation, reinforced by the weak outlook for the US dollar and local dollar-pegged exchange rates and a very high share of imported food, even as the acceleration in overall inflation will be brief before moderating, it said.
"Much of the region remains stuck deeply in deflation, reflecting ongoing demand weakness and price discounting," it said, adding "overall, regional inflation will be manageable this year, albeit higher than in 2019-20, with momentum remaining relatively flat in coming months."
The report said the dynamics of local food inflation capture the sharp increase in global food prices, which have risen by almost 30% since April 2020, as well as higher shipping costs. Both trends pose a challenge for the GCC because of their large amount of imported food (around 85%).
"However, our forecasts show food prices peaking this quarter, while shipping prices should also fall back as pandemic-related disruptions wane. Moreover, at 17%, food’s median weight in the CPI basket is markedly lower than in an average EM (just under 40%)," it said.
The dollar weakness has also contributed to a rise in local food prices, though nowhere near the experience of 2007-08, against the backdrop of weak demand. Local currencies have lost ground in tandem with the US dollar, with nominal depreciation varying between 1.2% and 4% over the course of the coronavirus crisis.
"Our view of the US dollar continuing to weaken in 2021 suggests import price inflation will persist in the near term. The impact is amplified because of the high share of imported food in the GCC," it said.
Stressing that the rise in food inflation is not a cause for concern because it has disinflationary counterweights; Oxford Economics said in particular, falling rents continue to make a large negative contribution to housing costs and overall inflation.
This segment, which makes up 27% on average in the region’s consumer basket, has been on a downward trend since late 2016. It has declined almost continuously since early 2018 in Saudi Arabia and the UAE and since early 2017 in Qatar.
And while prices are falling at a slower pace than they were previously in Kuwait, Saudi Arabia, and the UAE, they continue to act as a significant drag on headline inflation rates.
"The deflationary shock remains particularly strong in Qatar and the UAE, with 2020 average prices falling by 4.3% and 3.8% year-on-year, respectively," it said.
Local rents, which were among the main reasons for the inflation surge in 2007-08 (next to global food prices), are showing tentative signs of bottoming out but the downward pressure will only gradually unwind.
The slow return of expat workers will continue to act as a key catalyst, with the labour markets only just stabilising, it said.