The US-led bombardment on Houthi rebels in Yemen has rekindled worries of a wider conflict in the Middle East that could inflame prices just as inflation is starting to cool off. The dozens of Houthi attacks which began in October by the Yemeni Islamist movement have already led to diversions of shipping from the Red Sea.
Global shipping firms have continued to avoid one of the world’s busiest shipping lanes diverting journeys away from the Red Sea after Houthi rebels attacked commercial vessels. The Houthi rebels have declared their support for Hamas and have said they will target ships heading to Israel. The UK and US have launched air strikes against Houthi rebel targets in Yemen to respond to the attacks on shipping vessels. Because of the attacks many shipping firms such as the Mediterranean Shipping Company and Maersk are now diverting vessels to the Cape of Good Hope on the southern tip of Africa, adding thousands of miles to journeys. The disruption has increased the cost of shipments from Asia to Europe and has renewed worries about a fresh inflation shock for the world economy.
Economists expected the wider impact on goods prices to be contained. However, worries are growing as the knock-on effects for commodities, including oil, could be bigger than expected if US forces get more involved into a regional crisis since Hamas’s attack on Israel on the 7th of October.
What is happening in the Red Sea?
Iran-backed Houthi rebels in Yemen have been attacking commercial vessels in the Bab-el-Mandeb strait between the Arabian peninsula and the Horn of Africa since late November. Any ship passing through the Suez Canal to or from the Indian Ocean has to go through the strait of Bab al-Mandab and the Red Sea. For firms such as those transporting oil and liquefied natural gas, the Suez Canal is the quickest sea route between Asia and Europe. For example, in the first half of 2023, around 9 million barrels of oil per day were shipped through the Suez Canal based on freight analytics firm Vortexa.
15% of goods imported into Europe, the Middle East and North Africa were shipped from Asia and the Gulf by sea, including 21.5% of refined oil and more than 13% of crude oil. But container ships carry also consumer goods from TVs, clothes, to sports equipment. All these shipments are expected to be delayed adding to concerns about an increase in prices.
Could it rekindle inflation?
The costs of redirecting ships are forecast to reach $1m in extra fuel for every round trip between Asia and Europe, while growing insurance costs are adding to the overall cost of shipments.While global oil prices have risen due to concerns over delays in the Red Sea, crude prices have remained relatively stable and have been lower than in recent months.
The rising shipping costs can lead to inflationary shocks. During the Covid pandemic, the International Monetary Fund calculated that global supply chain disruptions added about 1 percentage point to inflation. Former government trade adviser Rhys Davies said freight costs had been impacted by the tensions in the Red Sea, but the effect on inflation would probably be limited.
Escalation of conflict could increase concerns
The Red Sea crisis is happening at a time when global central banks are starting to see the effect of higher interest rates which have managed to push inflation lower. But, this has affected households and businesses and slowed down economic growth increasing the prospect of recessions in the US, UK and EU nations.
The global freight costs may be lower than two years ago, but they have risen sharply in recent days due to the Red Sea disruption. The extra costs suffered by businesses could also be passed on to consumers, with higher prices at the pumps, which could push up higher inflation.
According to analysts, the biggest economic danger and more serious risk to inflation is if oil and gas markets become unsettled by the prospect of an escalating Middle East conflict. Despite the ongoing Israel-Gaza conflict, oil prices declined throughout October, November and December. After the US-led strikes though, the price of oil rose sharply highlighting fears in financial markets that the US-led response could spell more trouble ahead. A widening war in the oil-producing Middle East region could not only affect global business but also people’s finances.