By Mark John
(Reuters) – Weeks of attacks by Iran-backed Houthi fighters on ships in the Red Sea have paralyzed shipping in the Suez Canal, the fastest sea route between Asia and Europe that carries 12% of global container traffic.
For the European economy, already escaping a mild recession and trying to shake off high inflation, prolonged disruption would pose a new risk to its outlook and could derail central banks' plans to begin cutting interest rates this year.
Here are some factors policymakers will consider when assessing the situation and its impact.
What impact has this had on the European economy so far?
From a macroeconomic perspective, small to negligible. While the German economy ministry stressed it was monitoring the situation, it said this week that the only noticeable impact on production so far had been some cases of extended delivery times.
Bank of England chief Andrew Bailey agreed, telling a parliamentary hearing that it “didn't really have the impact that I would have feared”, but acknowledged that uncertainties remained real.
So far, no impact from the attacks has been seen on Europe's main economic indicators – including inflation numbers in December, which rose slightly across the region due to a mix of broadly expected statistical effects, some one-off events and some pressure on prices for services.
That could change – look next Wednesday for the preliminary PMI readings for activity in European economies in January and the first estimate of Eurozone inflation for the same month from February 1st. ECB President Christine Lagarde may address the issue in her press conference after the interest rate meeting next Thursday.
But why isn't it impacting the economy yet?
The main reason may be that the global economy as a whole is still underperforming, meaning there is plenty of underutilization in the system.
Take, for example, oil prices, the most obvious channel through which the problems in the Middle East could affect economies in Europe and beyond.
The story goes on
They haven't started yet because, as International Energy Agency chief executive Fatih Birol told Reuters this week, supply is solid and demand growth is slowing.
“I don’t expect a big change in oil prices as there is plenty of oil coming into the market,” he said.
German logistics giant DHL said it still has spare air freight capacity – not an option for everyone – because the global economy is “not quite getting going yet”.
This subdued economic situation also makes it more difficult for companies to pass on to consumers any cost increases caused, for example, by rerouting their journey through Africa. Many of them have rebuilt their margins over the past year and accept that they may just have to suck it up this year.
“Our best forecast at the moment is that we will be able to absorb the additional costs that we expect to be incurred and still … deliver an improvement in gross margin,” said Andy Bond, chief executive of Poundland owner Pepco Group, told Reuters.
Furniture retailer IKEA even said it would stick to planned price cuts and have the inventory to absorb any supply chain shocks. As long as enough companies do this, the disruption will have no impact on consumer price inflation.
CAN EUROPEAN POLITICAL MACHINES SEE THROUGH THIS?
No – because the longer the disruption lasts, the more likely it is to have an impact on the overall economy, even if only gradually.
Based on an IMF estimate of the impact of rising freight costs, Oxford Economics estimated in a Jan. 4 note that rising container shipping prices would increase inflation by 0.6 percentage points in a year. The ECB expects inflation in the euro zone to fall from 5.4% in 2023 to 2.7% this year.
“While this suggests that a permanent closure of the Red Sea would not prevent inflation from falling, it would slow the rate at which it returns to normality,” Oxford Economics concluded. However, she did not believe this would prevent the expected shift towards lower interest rates.
As an aside, the Houthi attacks and broader problems in the Middle East represent one of the “geopolitical risks” highlighted in the minutes of central bankers’ monetary policy discussions. The fear is of escalation – and this fear itself could influence the resulting decisions.
Finally – and we may be a long way from this – there is a possibility that the situation will encourage companies to move forward with plans put in place after the disruption to trade caused by the COVID-19 pandemic for alternative, more predictable delivery routes.
This could include longer but safer trade routes and “near-shoring” or “re-shoring” to bring production closer to key markets. But whatever options are being explored, there's a good chance they'll all have one thing in common: higher costs.
(Writing and reporting by Mark John; Editing by Catherine Evans)
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