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Energy costs have fallen from record highs, causing inflation in the United States and other major economies to slow significantly over the past year.
Nevertheless, the fight to control rising prices has not yet been won, and the possibility that inflation could surge once more is growing due to the continued disruption of one of the world’s most important trade routes.
Many container ships, oil tankers, and bulk carriers that transport raw materials have been forced to take a longer route across Africa as a result of attacks in the Red Sea by Houthi terrorists that Iran supports. This has increased the price of shipping and insurance.
“I do think that there is a level of complacency in the financial markets concerning the inflation outlook,” Sergio Ermotti, CEO of UBS, said Wednesday at the World Economic Forum in Davos, Switzerland. He cited higher shipping costs caused by assaults in the Red Sea, which were likely to translate into higher costs for goods. Ermotti was speaking about the inflation outlook.
He said it is hard for me to believe inflation will not be affected.
In December, headline inflation in the United States, Europe, and the United Kingdom all nudged upward, even before the increase in freight rates had time to flow through to consumer prices. The recent higher movements have revealed that bringing inflation back down to 2%, which is the rate that the Federal Reserve and other major central banks have set as their target, may be more challenging than it seems.
However, declaring triumph (about inflation) is far too soon. According to statements made by the governor of France’s central bank, Francois Villeroy de Galhau, this week in Davos, the task is still ongoing.
Gita Gopinath, the deputy managing director of the International Monetary Fund, made comments similar to those of these individuals. She was informed that the markets anticipated that central banks would switch from gradually increasing interest rates to decreasing them “pretty rapidly.”
She responded, “I believe it is premature to draw that conclusion.”
Several bankers and chief executive officers urged policymakers against decreasing interest rates too fast at the annual event in the snowy Alpine ski resort. This was because a myriad of factors might cause inflation to increase.
The fragmentation of supply chains, trade protectionism, climate shocks, and armed conflicts are all examples of what Gopinath refers to as “upside risks to inflation.”
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Mary Callahan Erdoes, president and CEO of JPMorgan Chase’s asset and wealth management division, warned about a different, more subtle risk. According to her, “people start spending more as soon as central banks begin lowering interest rates,” meaning they feel better physically. “You can experience an increase in inflation in an instant.”
Central bank officials in Europe and the United States have been raising their voices in opposition to traders’ belief that rate cuts are on the horizon.
Christine Lagarde, the President of the European Central Bank, stated on Wednesday that it is quite likely that the bank will only reduce interest rates during the summer but that “there is still a level of uncertainty.”
In an interview with Bloomberg TV, she stated, “I am confident that we have reached a peak (in interest rates),” given that there has not been another huge shock. She said the central bank must maintain high interest rates “for as long as necessary” to put inflation firmly on the road, leading it back to 2%.
Middle East Inflation risk
The escalating bloodshed in the oil-producing Middle East, where tensions are running high as the Israel-Hamas war continues to rage, could be the source of yet another jolt to inflation.
An extraordinary escalation of hostilities between the neighbours has taken place in recent days, with Iran and Pakistan carrying out strikes on one other’s territories in their respective countries. More than sixty Houthi sites were attacked by United States and British forces in Yemen last week. President Joe Biden stated that this action directly responded to the threat posed to the “freedom of navigation” in the Red Sea and the Suez Canal, which is adjacent to their territory.
Even though there have been conflicts, the prices of oil and gasoline have barely moved, and the prices of natural gas have decreased. The demand for these commodities has decreased, and a large supply exists.
Even if a probable increase in energy cost is the most significant threat to inflation, shipping delays and a persistent increase in freight costs could still be problematic.
According to PortWatch, a platform established by the International Monetary Fund and Oxford University, the daily traffic through the Suez waterway has dropped to its lowest level since March 2021, when a vessel known as the Ever Given closed the waterway for six days.
According to data provided by Drewry, a shipping consultant based in London, container shipping rates along many of the world’s major trade routes have increased by a factor of two during the middle of December. In some instances, these costs have even increased by a factor of three.
According to Oxford Economics, if these expenses continue to be elevated, they can slightly increase global inflation. This is despite the fact that they constitute a relatively minor portion of the total price consumers eventually pay for manufactured items.
According to Maersk CEO Vincent Clerc, the disruption in the Suez Canal might continue for at least another month. This warning was issued this week. CNN’s Richard Quest was present in Davos when he said, “The longer this is going to last, the more this is going to cost.”
It is possible that there could be a scarcity of containers, which will make the shipping delays and the increase in costs much more severe. The CEO of DHL, Tobias Meyer, stated this week in Davos that longer voyages in Africa may, for example, lead to a scarcity of containers in Asia in a few weeks “because that backflow is currently not happening at the pace people were planning for.” Meyer made this statement about the logistics company’s operations in Asia.