top of page
Search

Engineering demand destruction to “satisfy” lower supply


An expanded world economic downturn - caused by politically driven supply disruptions and aggravated by interest rate increases - is very likely by the end of 2022. And depending on the outcome of some factors, the world economy may remain in the doldrums for a very long time.



What caused the supply chain disruptions? First, there was the (still ongoing) trade war between the US and China, followed by the COVID-19 pandemic and lockdowns (with sporadic lockdowns in China continuing ). Also, new climate change (clean energy) policies and targets reduced energy produced by coal, gas and oil – but the decline in supply was not matched by an increase in cleaner energy production, contributing to energy supply shortages. And lastly, the war between Russia and the Ukraine limited the flow of oil and gas to the world, causing a shortage of electricity in especially Europe.


Supply disruptions, however, coincided with strong demand growth – a recipe for rising inflation. Indeed, the shortage of supply and strong demand caused the prices of especially oil and gas to add significantly towards consumer price inflation (CPI) rates last experienced in the previous century. Consequently, central banks intervened with front loaded interest rate increases to reduce demand, which contributed to somewhat lower oil prices and slower increases in CPI.


The outcome of higher interest rates is declining demand and economic growth - bearing in mind that gas prices in Europe are on a renewed increasing trend following a further reduction in supply from Russia? In this respect Purchasing Managers’ Indices (PMI’s) provide an indication of expected world economic growth. Markit’s global PMI continued its decline in July to 51.1 from 52.2 in June, reaching the lowest level in two years. Moreover, the subindex for global output showed no growth in July. In fact, output fell in economies such as the US, UK, Eurozone, and Japan.


In addition, supply was further curtailed when Europe agreed to a self-imposed 15% reduction in gas usage, which in itself will reduce industrial production and economic growth. However, as gas prices remain high the European Central Bank will probably increase interest rates by a further 50-75 basis points to contain CPI which increased to 9.1% in August from 8.6% in June. As such, the European economy is expected to shrink in Q3 2022 and falling into a deeper recession in Q4 2022, continuing a downward trend in 2023 to register negative growth rate of around 0.2%. The story is pretty similar in the UK. The Bank of England expects four consecutive quarters of contraction as it prepares for another hike of 25 to 50 basis points in interest rates.


In the US, Federal Reserve chairman, Jerome Powell, in his Jackson Hole speech reaffirmed the Fed’s commitment to bring CPI under control. As such, the interest rate may be raised by 50 to 75 basis points. However, China’s central bank reduced the one-year lending rate by 10 basis points in an attempt to stimulate demand following a range of disappointing economic data.


In South Africa, CPI may well reach a peak in August, but the Reserve Bank is expected to continue with hawkish rate increases. Another 75-basis point increase may again occur in September – despite a hefty decline in fuel prices and expectation of negative economic growth in Q2 2022. In addition, the US$ strengthened on the back of risk aversion, causing the rand exchange rate to depreciate to above R17/US$. The weaker rand and still high oil price (US$ 96 per barrel) will, however, limit the strength of the decline in CPI. In addition, as a growing number of goods and services in the CPI-basket are increasing, the SARB will remain hawkish beyond September.


Multivest Economic Division

10 views0 comments

Comments


bottom of page