Shipping cost: the forgotten inflation factor?

Remember when inflation was low?

Not so long ago, before the Covid era, some economists wondered why inflation remained low, around 2%, despite the generally accommodating policies of central banks.

The three most common explaining factors were:

• A demographic shift in the West: the ageing population, combined with low population growth, did not stimulate spending.
• A technological change: productivity had increased thanks to the automation and digitalization of the economy, allowing for less labor intensity, which had lowered costs.
• Finally, the most important factor could be that globalization had succeeded in reducing production costs, thanks to comparative advantages.

G7 inflation was structurally low for the last two decades

Covid and the “transitory inflation” theory

The main explanation for the 'transitory inflation' theory advocated by the FED back in 2021, was that logistical bottlenecks and supply chain disruptions would naturally resolve themselves:

• Once the supply chain bottleneck was over, inflation was expected to return to normal.
• This theory of transitory inflation, coupled with the target of pre-covid level of unemployment, explained the FED's dovish attitude at the time.

We now know that this estimate turned out to be wrong:

United States Annual Inflation Rates (2012 – 2022)

Shipping cost impact on inflation

Traditionally, inflationary shocks are caused by a surge in commodity prices: oil in the 1970s or the food crisis in 2008.

Many market participants have discussed the impact of the war in Ukraine and its consequences on oil and food prices.

However, the impact of freight prices is less documented but extremely relevant:

• A recent IMF study found that shipping costs were the most persistent factor influencing inflation over time.
• A price shock has an average impact of 2% on inflation, and freight cost account for around 7.5% of the value of imported goods.
• The last peak in container transport prices was a year ago, which means that this increase is still fueling inflation today.

Impact of shipping cost shocks on headline inflation, in percentage points

Conclusion

Following the last CPI release, there have been concerns about rising housing and wage costs and their lasting impact on Core Inflation.

This ran against the idea that falling commodity prices should drive inflation down.

Shipping costs are now less in the spotlight, but they are an extremely relevant and persistent medium-term factor in explaining inflation.