Red Sea attacks threaten to upend much-awaited inflation slowdown

Soaring shipping costs and a jump in oil prices are stoking worries about a revival of inflation pressures around the world.

Only days into a 2024 that was meant to be the year inflation dissipated, manufacturers and retailers are again juggling delays and facing higher expenses as persistent attacks by Houthi rebels in the Red Sea rattle a major shipping route through the Suez Canal. Ocean freight rates for goods from Asia to Europe have more than doubled over the past four weeks.

Fears of a wider regional conflict pushed up oil prices Friday after the US and UK led a military response to the attacks. Global benchmark Brent rose as much as 4.3%, briefly topping $80 a barrel.

Among the key reasons for the decline of inflation over the past year were a drop in energy costs and supply chains that had largely ironed out their pandemic strains. The Red Sea turmoil is reversing both of those disinflationary forces that central bankers were hoping could help them finish the job.

"This is a world in which we are fragile to begin with on the supply side, and then you get this additional shock," Mohamed El-Erian, president of Queens' College, Cambridge, and a Bloomberg Opinion columnist, said Friday in an interview on Bloomberg Television.

Meanwhile, Central America's Panama Canal remains restricted due to an ongoing drought that has limited the number of ships that can pass through.

While the shipping disruptions are nowhere near the levels of stress experienced during the pandemic, blockages in two of the world's most important trade arteries are prompting warnings from industry players that supply chains remain as vulnerable as ever.

"This is a very dramatic reminder that supply chains continue to be very fragile," said Stephen Lamar, president of the American Apparel & Footwear Association, which represents over 1,000 leading brand names. "It has an inflationary impact all across the freight industry."

The full extent of that inflationary impact, which will mostly be felt in Europe and the US, will take time to become clear. Most container ships already were avoiding the nearby Suez Canal, a shortcut between Asia and Europe that handles 12% of global trade. Now, US and UK militaries have advised all ships to steer clear of the conflict zone. That stoked fears that rates for oil tankers and bulk carriers that ferry vital commodities could surge, raising the risk of a new round of global inflation.

Even after the US and UK attacks, the conflict in the Red Sea is unlikely to spill over into the wider region, limiting the economic damage, according to Ziad Daoud of Bloomberg Economics.

A slump in merchandise trade and a surplus of freight capacity means the price pain won't be a replica of what it was during the pandemic. Chinese exports fell 4.6% in 2023, the first annual drop since 2016, underscoring weak global demand for goods.

"Global shipping costs have jumped and oil prices are up by a few dollars per barrel, but if this is the worst of the impact, which seems most likely, then it will not materially translate into higher consumer price inflation globally," said Moody's Analytics chief economist Mark Zandi.

Still, major players in the ocean shipping industry that handles upwards of 90% of global trade are bracing for months of cost-stoking upheaval.

The benchmark Shanghai Containerized Freight Index was up over 16% week-on-week to 2,206 points on Friday. The index, which measures non-contract "spot" rates for container shipments out of China's ports, has gained 114% since mid-December.

Rates on the Shanghai-Europe route rose 8.1% to $3,103 per 20-foot container on Friday from a week earlier, while the rate for containers to the unaffected US West Coast soared 43.2% to $3,974 per 40-foot containers week on week, leading ship broker Clarksons said on Friday.

"The longer this crisis goes on, the more disruption it will cause to ocean freight shipping across the globe and costs will continue to rise," Peter Sand, chief analyst at freight platform Xeneta, said in Friday.

Grocery pressures

In the UK, grocery chain Tesco Plc warned that the Red Sea shipping disruption could lead to inflation pressures.

"If they do have to go the whole way around Africa to get to Europe, it extends shipping times, it constrains shipping space and it drives up shipping costs," Tesco CEO Ken Murphy told reporters. "So that could drive inflation on some items, but we just don't know."

Those on the front lines of merchandise trade are seeing the changes in real time. Rachel Shames, who brokers shipping and freight for US importers and exporters, said a typical shipment from Asia to the US is now facing delays of 10 to 12 days. That means extra operational costs for fuel and staff, and less available capacity.

"It's a lot more time on the water and that is sucking up capacity that would normally be back and rotating in the market," said Shames, who is vice president of pricing and procurement at Virginia-based CV International Inc. "This is not something anyone saw coming."

Estimates by economists at Allianz Trade found that a doubling of shipping costs would lift inflation by 0.7 percentage point for Europe and the US, or an extra 0.5 percentage point for the world.

Oxford Economics estimates that a permanent $10 increase in the price of a barrel of oil would add 0.22 percentage point to UK inflation and 0.29 point to global inflation in 2024. The impact on growth would be to shrink global output by 0.07% this year and 0.09% in the UK alone.

'Canal crisis'

Andrew Goodwin, UK economist at Oxford Economics, said the increase in the Baltic Dry Shipping Index could herald a rise in UK goods prices but only if it was prolonged.

Europe's challenges come amid signs that US inflation may prove more stubborn than expected, complicating expectations for the Federal Reserve to lower interest rates this year. US inflation accelerated in December as a steady decline in goods prices petered out.

For now, retailers and manufacturers are bracing for how the disruption will play out over coming months, according to Craig Akers, director of operations at the Toy Shippers Association.

"I am coining this year, the 'canal crisis,' he said.

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.