Red Sea crisis: a new threat to global trade

Attacks on container ships by Houthi militants in the Red Sea have driven up shipping costs by over 300%, fuelling fears of supply chain bottlenecks and adding to inflation risks.

According to the Shanghai Containerised Freight Index (SCFI), the average cost of shipping a 20ft container from Shanghai to Europe hit USD 3,101 in mid January, a 310% rise on the figure in November. The increase is due to commercial vessels taking longer, costlier routes to avoid the conflict zone, alongside rising insurance costs.

While the attacks - ostensibly aimed at Israeli-linked vessels - are causing problems for shipping companies and the industries that rely on them, the impact on the wider global economy is currently limited. Most economists expect it to stay that way, at least in the short term. But the longer the crisis goes on, the more serious the disruption is likely to be.

The current situation: longer journeys, higher cost

Around 30% of all container shipping passes through the Red Sea, a crucial channel for freight travelling from the Asia Pacific (APAC) region to Europe. A number of major ocean freight carriers have suspended operations in the area, diverting vessels around the Cape of Good Hope.

According to calculations by Oxford Economics, a ship travelling at 16.5 knots from Taiwan to the Netherlands via the Red Sea and Suez Canal takes about 25.5 days to complete the journey. That increases to 34 days if the vessel has to sail around the southern tip of Africa.

The cumulative effect of nine more days at sea will inevitably disrupt and delay global logistics and supply chains. With ships at sea for longer, the effective closure of the Red Sea route could reduce international shipping capacity by around 20%.

Supply chain challenges and local impact

Longer and less certain supply chains are likely to lead to product shortages in some sectors, and European businesses will be hardest hit in the short term.

European manufacturers import a wide range of intermediate goods from China and APAC more widely, including electrical equipment, high-tech goods, rubber and plastics, chemicals and machinery. Longer waiting times, higher prices and congestion at ports are all possible if the crisis drags on. This may hasten a return to a greater willingness to keep higher precautionary inventory levels.

Away from Europe, Egypt’s economy is especially vulnerable to a prolonged Red Sea conflict. Just over 2% of the country’s Gross Value Added (GVA) output and 3.5% of government revenue are linked to the Suez Canal.

Slowing inflation unlikely to be reversed

Despite these challenges, the crisis is unlikely to reverse global trends towards lower inflation in the foreseeable future, or force the suspension of interest rate cuts pencilled in for the middle of this year.
“The impact of the Houthi attacks and the rise in shipping costs on global inflation is likely to be fairly limited,” says Niels de Hoog, Senior Economist at Atradius and a Middle East specialist. “At most, it will slow the rate at which inflation is currently normalising from the past post-pandemic peak.”

Niels sees three causes for optimism:

• Although shipping costs have risen substantially, they are still considerably lower than during the peak of the Covid crisis. “Moreover, the direct pass-through of a rise in shipping costs to inflation is generally limited, because shipping costs represent only a small part of the consumer price of products,” he says.
• The Houthi threat has so far had little impact on oil prices, the main driver of inflation during the post-pandemic recovery. At the moment, oil prices are actually a little lower than they were in the months before the attacks began. About 80% of oil exports from the Gulf region go to Asia, and do not go through the Suez Canal.
• In this respect, the biggest threat to inflation and the global economy is a regional escalation of the conflict directly involving Iran and leading to a blockade of the Strait of Hormuz – the key chokepoint of global oil trade.
• Any slowdown in production caused by supply chain challenges is happening against a backdrop of subdued global demand, which means the impact on inflation is likely to be quite minor.

The longer-term outlook

The hope, then, is for a relatively short crisis that avoids escalation involving Iran or its proxy, Hezbollah, and leaves the wider global economy relatively unscathed. There is strong international pressure for that outcome. A US-led coalition has already signalled its intent to protect shipping passing through the Red Sea, through naval patrols and airstrikes on Houthi positions in Yemen.

But in an unstable region, tensions can quickly escalate, and there is currently no end to the crisis in sight. We expect that, if the Red Sea were closed to shipping for several months, and freight costs remain high, the result could be 0.7ppts added to annual CPI inflation rates by the end of 2024 (currently forecast to decrease to 4.1%, from 6% in 2023).

Again, that isn’t enough of an inflationary push to reverse current trends, and it’s unlikely to see central banks rethink rate cuts entirely. But it may make them think twice about how low interest rates can go in the medium term.

“For these reasons, all hopes are pinned on a ceasefire between Israel and Hamas, but there are no signs this will happen anytime soon,” says Niels. “The Houthi threat is likely to remain hanging over the market for the duration of the Gaza war. We just don’t know at the moment how much of a threat it will ultimately turn out to be.”