Will Red Sea Attacks on Cargo Ships Spark Inflation?

Houthi rebels are bombarding cargo vessels and oil tankers in the Red Sea, prompted by Israel’s invasion of Gaza due to the Hamas assault on Israeli civilians. The danger is forcing massive diversions of shipping—between Europe and Asia—to a longer, more expensive route around South Africa’s Cape of Good Hope.

The situation has stoked fears that the global decrease in inflation will be hindered and maybe even reversed—and that plans by the Federal Reserve and other central banks to cut interest rates might be thwarted. LPL Financial, however, thinks any such threat would be minor.

The ocean-going detour adds an average 3,500 nautical miles and 10 to 12 extra days of sailing time to the trip. The peril has cut the number of commercial voyages through the Red Sea by half, according to the Center for Strategic & International Studies. The U.S. and UK have launched numerous strikes against Houthi targets in Yemen, in a bid to diminsh the militants’ ability to attack shipping.

Should the disruptions persist over three months, Allianz, the French insurer, estimated that inflation could rise 0.75 percentage points and reduce economic growth by almost a full point in Europe. A similar scenario could take place in the U.S. The price of oil, which had been dropping since last September, is up 6% this year.

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A related problem is besetting the Panama Canal, owing to a drought that has caused lower water levels. The impact is less severe for traffic through the Panama Canal than via the Red Sea: It is down by slightly more than a third, Panamanian authorities reported.

In a research report about the Red Sea problem, LPL acknowledged that “hampered supply chains indeed impact goods producer prices, and we should expect firms to pass along those higher prices to the end consumer.” The last time that happened, stemming from the pandemic’s supply-chain snarls, the Consumer Price Index surged to an annual 9.1% gain by mid-2022.

But this time should be different, the investment firm’s analysts opined. Thanks to tightening by the Fed and its peers, the prices of durable goods—as in much of what the cargo ships are carrying—have fallen. Starting from the pandemic’s onset in early 2020, these goods are down 2%, according to LPL. In other words, the ships’ cargo has a built-in cushion against inflationary forces.

“So, although supply disruptions will likely bring upward pressure on goods prices, we don’t think the temporary shock” will divert the Fed from its intention to reduce rates this year, the study contended.

As the report put the matter, ”Shipping disruptions in the Red Sea could temporarily impact goods prices, but not at the same magnitude as during the pandemic. Tight financial conditions, slowing economic growth, and a disinflationary trend all support the Federal Reserve’s pivot away from tightening monetary policy to easing in the new year.”

Hence, in LPL’s view, “Despite these longer term trends, rates possibly got ahead of themselves in recent weeks, exhibiting higher volatility.”