Timing is important for economic outcomes. During the pandemic, a series of unfortunate events all occurred at the same time to exacerbate the impact on the economy. Now, in the latest threat to the global economy, disruptions in the Red Sea have led to a substantial shift in shipping lanes. LSEG shipping analytics data show that container ships passing through the Suez Canal are down 30% year-on-year. Many ships are instead sailing around the southern tip of Africa, passing the Cape of Good Hope. However, this time around, there are a few elements of luck than mean the impact on the economy from the increased shipping costs will be less severe than it otherwise could have been.
The first piece of luck is the timing of the disruption. Imports are seasonal, with Europe importing more in Q4 than in Q1, due to the festive season. Disruptions in the Red Sea really escalated at the end of 2023 and so did not have a material impact during the busiest quarter. In the five years to 2019 (pre-COVID), quarterly import growth for the euro area was 5.4%. The quarterly figure tends to drop by 2.2% in Q1. The disruptions so far this year have come at a good time. Of course, this benefit will not be sustained if disruptions remain in place throughout the year.
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The second piece of good fortune reflects the macroeconomic backdrop. The disruptions predominantly impact the goods trade, which has been in something of a recession following a large boom during the pandemic. Goods inflation has tended to be lower than headline inflation in major developed economies, aided by deflation in annualised import prices.
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Next, this weakness in manufacturing means that there is capacity in the system to absorb delays. Admittedly, the delays to goods have affected some large companies relatively more, with Tesla announcing a shutdown in January related to Red Sea disruptions. However, survey data suggest that the shock has been absorbed without huge disruption to production lines. Current selling prices for manufactured goods and the prices expected in three months’ time remain within normal ranges, according to the ifo Institute in Germany (Leibniz Institute for Economic Research, at the University of Munich).
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Disruptions are a negative supply shock, putting upward pressure on prices and reducing economic activity. But the final piece of luck is that central bankers have the luxury of waiting out any temporary effects, given that inflation expectations remain fairly well anchored. Central banks with credibility can look through those types of shocks. True, many developed market central banks lost some of their credibility during the pandemic, but they have largely regained it after a steep rate-hiking cycle. And market pricing is largely in ranges that are consistent with their targets, albeit above pre-COVID levels. If the view of investors is reflected among economic agents more broadly, then that will reduce the risk of second-round effects via expectations.
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Disruptions in the Middle East are the latest in a series of unfortunate events for international supply chains. They are a warning that rising geopolitical tensions risk putting upward pressure on prices over the medium term. However, the latest shock has arrived at a good time, with soft global manufacturing activity leading to spare capacity in the system. That, coupled with well-anchored inflation expectations, means that central bankers can largely look through it for now. We will of course be monitoring the situation for pockets of risk and equally for signs of de-escalation.
The views expressed in this article are the views of the author, not necessarily those of LSEG.
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