Cargo hit by rocket fired by Houthi rebels
Inflation, will Suez Canal disruption derail rate cuts?
Growing geopolitical tensions in the Middle East have begun to create disruption in global supply chains. Following the attacks by Houthi rebels on ships crossing the Red Sea and which sail towards the Suez Canal and the main global economies, major shipping companies have reported significant delays in deliveries. Satellite images show that virtually no ships bound for major European, US or British ports are crossing the Red Sea, preferring instead to divert to southern Africa.
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This latest disruption follows problems in the Panama Canal, where a combination of drought caused by climate change and changes in rainfall due to El Nino have caused water levels to drop. At the same time, in Europe, humidity means that the level of the Rhine, a key shipping route for German producers, is too high. Furthermore, given that the upcoming elections in Taiwan pose the risk of new military exercises by China, such as those that disrupted Asian shipping lanes in 2022, It appears that global supply chains are facing a perfect storm filled with risks.
All of this brings back painful memories: the supply chain problems that erupted during the Covid-19 pandemic. They have contributed to the recent rise in inflation, which ultimately forced global central banks to aggressively raise interest rates. Markets are currently pricing in aggressive interest rate cuts in Europe, the UK and the US, with some cuts already expected in the first half of 2024.
All of this raises questions about whether new supply chain problems will lead to higher inflation, forcing policymakers to revise their outlook. Much will depend on the duration of the current upheavals, but at least Three important differences in the global economic environment suggest that problems in the Red Sea are unlikely to lead to a significant rise in inflation.
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First, demand conditions are currently much weaker. While extensive monetary and fiscal stimulus supported the global economy after the initial disruptions caused by the global pandemic, growth is currently slowing. We forecast global GDP growth of just 2.5% both this year and next. The Eurozone is probably already in recession, the UK is seeing some weakness and activity in the US is cooling.
Secondlywhile lockdowns to contain the spread of Covid-19 meant that demand was concentrated in the goods sector during the pandemic, consumption patterns are now much more balanced. Indeed, the reopening of economies has resulted in demand shifting back towards services over the past two years, leaving the global manufacturing sector in recession.
Third, on the supply side, the global economy is also in much better shape. While, during the pandemic, production was completely blocked due to lockdowns that were imposed and then removed, now there are no upheavals of this type. Diversions around southern Africa will lengthen delivery times, but goods will still reach their destinations, suggesting real shortages are unlikely. Furthermore, recent trade data from China, which shows much faster growth in exports in terms of volumes than values, suggests that companies, at least in some sectors, are forced to discount prices to dispose of excess capacity.
Risks for the supply of raw materials
A more immediate risk to global inflation would arise if tensions in the Middle East begin to impact commodity supplies, particularly by driving up energy prices. This is something we have started to monitor in our latest forecast cycle. In one of our scenarios, focused on geopolitical crises, we hypothesize that, in addition to trade frictions, a widening of tensions in the region could push oil prices towards USD 120 per barrel. Our simulation predicts that the global economy would move towards stagflation, as rising energy costs would push up inflation, with the risk of secondary effects (given the rigidity of labor markets) that would weigh on growth, forcing central banks to give up rate cuts and, perhaps, even further increases.
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However, So far, oil prices have performed well and Brent crude oil has remained largely unchanged at just under USD 80 per barrel. However, at the very least, the latest snag in transportation routes is yet another reminder of the risks associated with long supply chains in an increasingly fragmented world. As a result, the overhaul of global supply chains, which is a key pillar of our “3D reset” scenario, looks set to continue.
*Senior Emerging Markets Economist, Schroders
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