Clouds are once again gathering, marring the outlook for the global economy. As inflation accelerates, putting pressure on households’ finances and businesses’ margins, and causing central banks to tighten monetary policy aggressively, a recession is again on the horizon in many economies.
With the performance of the chemical sector generally tracking that of GDP, the outlook for the industry is therefore tightening too.
It was not long ago that the COVID-19 pandemic brought a big part of the economy to a halt, and while the recovery has been relatively swift once restrictions were lifted, its strength has varied across countries.
With all the new challenges this year, it is easy to forget that the virus has not yet disappeared. We could see a rise in infections over the colder months, including more disruptions to production in China due to the zero-COVID policy. The impact on labor supply and the health service is also likely to linger, causing a tighter labor market and an additional burden on public finances in the medium term.
Supply chain and geopolitical pressures
Shifting global politics and rising geopolitical tensions are changing the international order that came out of the cold war. The chemical industry is expected to continue to contend with disruptions to oil, gas and feedstock caused by a new era marked by instability. These transformations are characterized by weaknesses in global governance, a rise of conflict, and mounting backlashes to multilateralism and free trade. The rise of a multipolar, less globalized world has been accelerated by the global pandemic and the war in Ukraine.
Pressures on global supply chains have eased since their peak late last year, despite the setbacks caused by the Russia-Ukraine war. However, they remain at historically high levels, contributing to the rise in costs experienced by many producers. While we expect the weakening in global economic activity to ease the pressure on supply chains in the short term, other factors could work in the opposite direction.
With growing geopolitical tensions, more friction in supply chains could become the norm. And as labor costs rise in less developed economies and changes in production methods in some industries favor a more localized presence, there may also be less impetus for companies to seek production sites further afield, causing globalization to be on the retreat. All this could see inflationary pressures remaining more elevated over the longer term.
Although less globalization means less growth and higher inflation — as supply chains restructure, downsize and even duplicate — certain domestic producers stand to benefit from governmental efforts to localize and subsidize production in nationally strategic sectors, including the chemicals industry. Massive industrial policies have been enacted in some of the largest economies, showing more willingness on the part of governments to intervene in markets and bolster supply chain resilience, even at the cost of economic efficiency and trade liberalization.
The scarcity of workers has contributed to supply bottlenecks and more elevated inflationary pressures. As COVID-induced restrictions were lifted, demand for labor rose sharply. But the availability of workers fell in many countries, as some were affected by the pandemic while others chose to retire early. As a result, unemployment rates fell swiftly and have reached pre-COVID levels or below. This is also exacerbated by global demographic trends that will see, in the next 5 to 10 years, the retirement of the biggest generation we have ever had — the Boomers — who are not going to be replaced, in terms of productivity, consumption and investment capacity, by the much smaller Millennials’ generation, and even smaller Gen Z.1 Not all counties will face demographic collapse. Still, many economic centers, such as Germany, China, Italy, Japan, Russia and others, will need either productivity or a migration miracle to avoid a severe hit to their growth prospects.
While a weakening economic environment will likely see a fall in vacancies, the labor market could remain relatively tight over the next year.
The chemical industry is expected to continue to contend with disruptions to oil, gas and feedstock caused by a new era marked by instability.
Energy prices stoking inflation
Although inflationary pressures were already present as economies reopened from COVID, the invasion of Ukraine by Russia added an extra strain, with a range of commodities exported by the region seeing their price rise significantly. More recently, some prices have moderated somewhat, and supplies have adjusted while demand eased as the economy slowed.
Energy prices have been at the center of the inflationary surge; although oil prices have moderated lately, contributing to a minor easing in annual inflation figures in many countries, they remain incredibly volatile, with price fluctuations not seen in decades. The price of gas remains heavily impacted by the conflict in Ukraine, with the rush to secure shipments of liquefied natural gas (LNG) for winter, causing not just European but also Asian gas prices to spike recently. It is still uncertain whether sufficient gas supply will be forthcoming over the winter months. This could prove a significant blow to the short-term outlook of some European economies, which rely more on the Russian supply.
The combination of supply chain bottlenecks, generous government spending, tight labor markets and a commodity shock triggered by the Russian invasion of Ukraine caused inflation to shoot well above central banks’ targets across many developed economies.
A moderation in 2023?
It is expected that inflation may moderate significantly from the middle of next year, and we assume, with a bit of wishful optimism, that the global energy shock will subside. However, we could be entering a structurally more inflationary environment as production costs — from materials to energy and labor — remain elevated.
Faced with inflation well above targets, an immediate concern for most central banks is that inflation expectations stay high while their credibility in fighting inflation is lost. The need for fiscal support is likely to stoke more inflation in the medium term, placing fiscal policy actions at odds with the aims of central banks in meeting their mandates. In the cases where investors have been led to question the sustainability of public finances, such as in the UK in late September 2022, depreciating currencies and rising borrowing costs have exposed vulnerabilities and increased the risk of contagion.
That is why central banks are likely to be more hawkish in their response to what could be a relatively short-lived burst in inflation, with markets penciling in aggressive rate rises over the coming months.
Moreover, suppose inflationary pressures are to become embedded. In that case, interest rates may stay at higher levels than we saw in the past decade, even after the current spike in inflation subsides. This would represent a significant shift in monetary policy in a relatively short time.
Rising costs are taking their toll on consumers, with a cost of living crisis putting a significant dent in households’ purchasing power. Consumer confidence has taken a big knock across most economies, and spending is following suit, causing overall economic growth to weaken.
Global companies that are reliant on foreign energy and feedstock inputs, like the chemicals industry, will have to invest more money and brain power to boost productivity, develop new technological solutions and build supply chain resilience to be able to protect margins against the combined forces of inflation, deglobalization and a new, more unstable geopolitical environment.
Forecasts: A mild slowdown
The overall forecast for the world economy is for GDP growth to moderate to 1.9 percent in 2023 after growth of 2.7 percent in 2022. Weaker growth could see inflation moderate to 4.7 percent in 2023 after averaging 7.6 percent in 2022, according to KPMG forecasts. But as economies worldwide brace for another period of headwinds and a slowdown in activity, the hope is that the downturn will be relatively mild on this occasion.
Major economy outlooks
China – Balancing COVID containment with supporting economic growth
China will likely stick to its COVID containment policies in the near future. The key issue to watch is how the government balances the objectives of controlling the pandemic and maintaining economic growth. The property market has faced considerable headwinds since H2 2021, and the pressure continues to mount. The slowdown has greatly impacted on investment, bank loans and housing-related consumption. The Chinese government has taken a series of fiscal and monetary policy measures to stimulate demand. More efforts are expected to be announced to support growth.
In contrast to most other economies, inflation has remained relatively low in China, giving the government some room in its monetary policy. Along with Japan (as below), China is the only major economy in the world that is still adopting an easing approach to support growth. China’s inflationary pressure is likely to gradually pick up through H2 2022 due to rising food prices and a consumption recovery.
But the re-emergence of new, highly transmittable variants of COVID-19 could lead to more prolonged economic disruptions. Risks could also stem from persistent stress in the real estate sector with more economy-wide consequences. China’s economy is also broadly vulnerable to risks related to the global outlook and geopolitical competition with the US and the West. With challenging demographics, ongoing COVID disruptions and less global economic integration, it will likely be challenging for China to maintain its role as the world’s foremost manufacturing engine.
Germany — Europe’s biggest economy threatened by recession
In Germany, a positive first half-year is overshadowed by negative expectations, with high energy prices and a gas shortage endangering economic growth. In August, energy prices were 35.6 percent higher than in August 2021. In the same context, the electricity price for industry exceeded that for households for the first time. As a result of the country’s efforts to become less dependent on Russian gas, imports have fallen sharply. The country is having to reduce overall energy demand ahead of winter, including by scaling down manufacturing.2 High electricity demand, the massive price jumps on the procurement markets, expensive production and uncertainty regarding gas imports will likely cause energy prices to rise further in the coming months. Meanwhile, exporting companies are suffering significantly from the overall global recession and decreasing demand from their most important trade partners. Supply chain disruptions continue to be a significant challenge for several industries — because of material bottlenecks, more than one in two companies have already changed their procurement strategy for critical raw materials.
Japan – Loose policy keeping the yen down, adding to inflation
In Japan, headwinds to households are mounting, while exports are being weighed down by the global environment and lockdowns in China, which have put a drag on demand. Japan had a slow start to 2022, with GDP rising by less than 0.6 percent in the last six months. Nevertheless, the continued relaxation of COVID restrictions enabled a solid rebound in consumption — but momentum is expected to ease during H2 2022 as household budgets are squeezed by a step up in inflation, which has risen above the Bank of Japan’s target and has further to rise in the months ahead. The Bank of Japan’s continuation with loose policy settings has caused the yen to depreciate to its lowest level in decades.
US – Economy poised to stall
The Federal Reserve has committed to raising rates and holding them high for longer to bring inflation back to its 2 percent target slowly. The goal is to prevent a more entrenched and persistent inflation cycle from taking root with a mild but prolonged recession. Economic growth is expected to slow below the economy’s potential growth rate, while employment is expected to stall and lose ground as we get into 2023. The unemployment rate is expected to cross 5 percent by year-end 2023, and 5.5 percent before inflation fully cools. Fiscal stimulus is expected to remain limited as pandemic aid wanes and infrastructure projects take time to ramp up. Mid-term elections are expected to play a key role in determining whether the White House can deliver more on its promises to curb climate change and deal with social issues.
UK – Economy marred by stagflation
The UK economy is probably already in a mild recession, with growth expected to stay negative for the rest of this year. Inflation is set to peak at 10.5 percent in the UK as government policies limit the impact of energy price rises on households’ utility bills. A package of government support measures for households and businesses, and a reversal of significant tax increases, are set to provide a sizeable fiscal boost. Nevertheless, high inflation erodes the actual value of earnings, and rising interest rates, which raise the cost of debt, have created an unprecedented squeeze on household incomes. Investment is also expected to remain weak throughout the next 15 months due to weaker growth lowering investment returns, higher cost of borrowing due to tighter financial conditions, and the expected phasing out of the government’s super deduction scheme on plant and machinery investment, which is due to end in March 2023.
1 Financial Times, Global population growth hits lowest rate since 1950, July 2022.
2 The Guardian, How gas rationing at Germany’s BASF plant could plunge Europe into crisis, 15 September 2022.