J.P.Morgan: Oil supply shock to test global resilience

1. Oil price shocks can have a positive correlation with GDP. The impact of rising oil prices depends on the source of the shock, and economies can absorb shocks over time.

2. Rising crude oil prices have caused global energy prices to increase, pushing CPI inflation up to 5%. This will result in a 1%-pt shock with a 4%ar increase in 2H23 CPI inflation.

3. Some of the move owes to stronger demand, but a larger supply shock will be a drag. J.P.Morgan‘s model suggests global GDP could be damped by 0.5%-pt (ar) over two quarters if prices sustained

Oil prices have jumped nearly 30% over the last two months, posing downside risk to the outlook. Calibrating the magnitude of the impact is complicated, however. Here J.P.Morgan decompose the latest oil price shock into is causes, estimate its impact on growth and inflation, and stress-test the outlook with an even bigger shock to gauge the resilience of the expansion.

The recent rise in oil prices, largely due to a negative supply shock from OPEC+ production cutbacks, is expected to have a significant impact on global GDP growth and inflation. Our model suggests a 0.5%-pts drag on global GDP growth over two quarters, while global headline CPI may increase by 2%ar points in 2H23. If crude prices drop back to $86/bbl next quarter, the impact of the oil shock is likely to fade quickly. However, there are concerns about central banks' ability to look through any oil price shock in the future.

It would be a mistake to simply assume that all oil price shocks lead to material downturns in economic activity. Indeed, a casual inspection of changes in the price of oil and global GDP over the past half century suggests that crude prices and GDP more often than not share a positive correlation.

In general, there are several factors underlying the relationship between oil prices and economic activity：

1. Above all else, know your source: As with all price movements, the impact of rising oil prices on the economy depends heavily on whether the source is a demand shock or a supply shock.

2. Speed kills: With time to adjust, economies are able to absorb a multitude of shocks. Even a large supply shock that raises the price of oil significantly will not necessarily short-circuit an expansion as long as the shock is introduced gradually or fades quickly.

3. Contributing factors: Oil price shocks are often related to factors that magnify their impact. In particular, the link of price spikes to geopolitical events has regularly amplified shocks through tightening financial conditions and weakening confidence.

Crude oil prices have risen 27% since Q2 2023, passing on to consumer prices. Global consumer energy prices are up 13% in the past three months, pushing headline CPI inflation up to 5%. Unlike last year, natural gas or other commodity prices have not increased similarly. US jet fuel prices surged by more than 40%, while US CPI gasoline is up 57% in the past three months. The energy price increase will result in a 4%ar increase in 2H23 CPI inflation, translating into a roughly 1%-pt shock.

The impact of rising oil prices on economic growth is complicated as it reflects both supply and demand impulses. While global GDP is expected to expand by 2.4% this year, robust demand for petroleum has been driven by a shift in demand from goods to travel-related services following the pandemic. However, the extension of Saudi's supply cut and Russia's reduction in exports for another three months has rattled markets, making this the largest cut outside of recessions over the last two decades. The latest supply shock will dampen growth in the coming months.

J.P.Morgan use a simple equilibrium model to evaluate the impact of demand and supply shocks on GDP growth and oil prices. Assuming a 27% increase in oil prices due to stronger demand and a negative supply shock, the model shows that the assumed demand shock requires stronger growth, resulting in a 0.5%-point increase in global GDP growth, while the larger supply shock lowers global GDP growth by 1%-point. If sustained, the recent moves in oil prices could dampen annualized global GDP growth by 0.5%-point over two quarters. However, there is concern that the supply shock to oil is not over, which could push crude oil prices up to $120/bbl, causing another 26% jump and subtracting an additional 1.3%-point (ar) off global GDP growth over two quarters, pushing the global expansion to a near stall.