Lockdowns in China, the Russia-Ukraine war, higher cost pressures, and a tightening monetary policy backdrop have rattled supply chains in recent months. However, supply chain pressures are demonstrating signs of loosening.
The Global Supply Chain Pressure Index—an index measuring manufacturing and transportation pressures—continued to tumble over August. Nevertheless, pressure levels remain elevated and just below those seen during the first COVID-19 lockdown in Q2 2020 (Exhibit 1).
Exhibit 1: Recent easing of supply chain pressures fosters a pullback in producer price inflation
Despite initial concerns that lockdowns in China could trigger a further wave of bottlenecks, these fears seem to have been exaggerated. Japanese industrial firms, which have strong links with Chinese manufacturers and might be expected to suffer hard from the lockdowns, have recovered quickly. It seems that measures taken by China to limit disruption to the manufacturing sector, such as requiring staff to work in socially isolated bubbles, have proven relatively successful (Exhibit 2).
Exhibit 2: Japanese manufacturing output springs back
Ocean freight rates are declining as well, with the Global Container Index falling further over September. Although ongoing congestion at ports and labour shortages mean container rates continue to remain around three times the pre-COVID average, freight rates are more than 50% less than what they were over April 2022. This is largely being driven by rates from Asia to the east coast of North America continuing their descent (Exhibit 3).
Exhibit 3: Global container index declines further as China-to-US freight rates continue to slide
The recent slowdown in shipping rates coincided with lockdown measures being introduced in China. But encouragingly, freight rates have continued to drop since restrictions have eased. A key factor behind this is likely to have been easing goods demand. While this partly reflects a rotation of demand from goods back to services, the sharp deterioration in the global economic outlook has also clearly played a role, which means that the drop in shipping rates is not quite as good news as it might seem.
Other cost measures are beginning to paint an encouraging picture, however. While the OECD’s producer price index of global headline manufacturing climbed to its highest level in June since the data began in 1983, the index also peaked as supply chain pressures continue to ebb.
That said, while easing supply chain cost pressures may push down in inflation, this may be swamped by surging energy costs, particularly across Europe. Russia’s move to indefinitely suspend natural gas supplies to the continent at the start of September and several leaks recently found in the Nordstream 1 and 2 pipelines mean that we expect gas prices to remain elevated over the coming months.
This, combined with the euro falling below US$0.99 for the first time in the past two decades, means liquefied natural gas (LNG) imports from the US will be more expensive for Eurozone economies (Table 1).
Table 1: Accelerating producer price inflation across a number of countries
With firms set to face a prolonged period of higher energy bills, it is likely energy-intensive industries will pass on rising input costs to their end-consuming sectors in varying degrees. At a global sectoral level, factory gate prices have been rising the most in the fuel refining industry. Although selling prices fell in July, they remain around double what they were at the start of 2022 (Exhibit 4).
Downstream sectors that are heavily reliant on refined petroleum products—such as transportation—are expected to take a hit. As higher prices feed through to employees in the transport and logistics industry, increases in the cost of living could lead to further rail and port strike action, fuelling additional trade disruptions.
Exhibit 4: Producer price inflation strongest in the fuel refining sector
A still grim outlook
On balance, while there is some good news of supply chain bottlenecks unwinding, the outlook remains gloomy.
Inventory levels relative to underlying demand are generally improving since this same time last year and are a good sign in the context of managing supply chain pressures. However, if they rise further amid a continuing demand slowdown, this could lead to a negative “whiplash effect”.
In this instance, retailers beginning to overreact to falling consumer demand for manufactured goods could result in further misalignments along the supply chain in the form of too much stock and holding costs for manufacturers and distributers. While we do not see a risk of this yet, monitoring inventory trends carefully will be key.
Elsewhere, with Russia tightening its grip on natural gas supplies to Europe, higher gas prices and possible gas rationing across European countries could mean energy-intensive industries face the risk of temporary shutdowns of production, creating shortages further up the supply chain. Increasing gas storage across European countries, however, may help alleviate some of this risk.
Greater demand and competition between European and Asian countries for LNG is also anticipated to drive market prices higher. With this, further global supply chain imbalances could emerge as advanced economies outbid developing countries for LNG, disrupting their energy needs and production processes.
Kiki Sondh
Kiki Sondh is an economist at Oxford Economics. She produces global macroeconomic research and forecasts on Lithuania’s economy. Prior to working on the Global Macro team, Kiki was an economist on the Global Industry team where she covered industry research and forecasts on the transportation and logistics sector.
