Will inflation start to rise again?

With shipping movement through the Red Sea down by around two-thirds from more ‘normal’ levels, as ships take the – much longer – Southern Africa route, prices are starting to rise.

>> Will the 2% inflation target be readily attained?

We have all become acutely aware in recent years of the inflation surge that can result from supply disruption, especially in shipping. And while the huge disruption caused by the pandemic will hopefully never be repeated, the experience may have left policymakers and financial markets particularly sensitive to even smaller-scale supply disruptions, like the one currently being seen in the Red Sea as the Houthis attack shipping in the region.

With shipping movement through the Red Sea down by around two-thirds from more ‘normal’ levels, as ships take the – much longer – Southern Africa route, prices are starting to rise and some retailers are warning that there could be a lot more in store. If we look at the China to Europe shipping route, we can see that the Freightos index of shipping costs has more than doubled since the start of the year, while a route such as China to the US West Coast has seen a more modest 70%-plus increase. While this sounds significant it is still small beer compared to the disruption – and heightened costs – seen during the pandemic.

Another point to make is that the COVID-19 pandemic saw shipping effectively stop whereas now, shipping is still ongoing; it is just taking longer to arrive. This too suggests that the price impact should be far more modest. The demand in Europe has weakened considerably and hence there’s not the pent-up pressure on prices that we saw develop as shipping slowly started to recover when the pandemic eased.

In other words, while there might have been some evidence that firms took advantage of the mismatch between demand and supply during the pandemic to “price gouge”, that’s going to be a lot harder now. Hence, trade disruption caused by the tensions in the Red Sea could not lift inflation materially again; either in Europe or the US.

However, there is a caveat. It is that tensions in the region do not escalate to an entirely new and dangerous level. But this is clearly a risk, for after recent Houthi attacks, and a UN resolution on Wednesday demanding an immediate end to Red Sea aggression, US and UK warships in the area launched their own retaliatory attacks on the Houthis in Yemen overnight. This action could clearly have wider repercussions that might possibly prove more inflationary. Commodity prices, for instance, could be a conduit for some of this pressure.

>> Better signs of inflation cooling

Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said with China one of the countries that abstained in UN’s recent vote, it seems possible that any US/UK attack on Houthi positions could sour relations still further here and again have connotations for global trade and inflation. All told, it is not as if the situation is without its risks, both in terms of geopolitics in the immediate region and beyond, and possibly for inflation as well.

Most likely, an extended and volatile period of tension in the Red Sea, but without the major geopolitical consequences described just now, will serve to accelerate the drive by firms to ensure the security of supply, and that can ultimately be inflationary over the long haul.

“We doubt that this sort of issue poses an immediate risk of inflation bouncing back up this year and stymieing central bank efforts to cut rates. But it does play into the narrative that inflation in developed countries will, on average in the future, be higher than we saw during the pre-pandemic years”, said Mr. Steve Barrow.