What are the consequences of the events of the Red Sea for the European economy?

Weeks of Yemeni naval operations against Israeli ships in the Red Sea have caused shipping companies to distance themselves from this region, which is the fastest sea route between Asia and Europe and has a share of 15% of global maritime trade.

For the European economy, which has bypassed a mild recession and is trying to get rid of high inflation, the continuation of prolonged trade disruptions may derail plans by central banks to start cutting interest rates this year.

In a report, Reuters examined the factors that policymakers consider in evaluating the consequences of these disorders:

This consequence has been small or insignificant from the point of view of macroeconomics. Germany’s economy ministry announced last week that the only significant impact on production so far has been a few delays in delivery times. Andrew Bailey, the governor of the Bank of England, said in a parliamentary session that these events may not have the effect he feared, but there are still uncertainties.

No impact from the attacks has yet appeared on Europe’s main economic indicators, including December inflation, which rose slightly. But this situation may change. European Central Bank President Christine Lagarde may raise the issue at a press conference after Thursday’s interest rate-setting meeting.

The impact of the developments in the Red Sea on the world economy

The global economy is still far from optimal performance. For example, the price of petroleum, which could have increased due to geopolitical tensions and hit European economies and other regions of the world, did not rise significantly because, according to Fatih Birol, executive director of the International Energy Agency, supply is strong and demand growth is slow. He told Reuters last week that he doesn’t expect a big change in petroleum prices because there is plenty of petroleum in the market.

German logistics giant DHL said it still has available air cargo capacity that not everyone wants because the global economy is not performing as well as it should.

This bleak economic picture makes it difficult for companies to pass on any higher costs resulting from increased shipping costs to consumers.

Even home appliance company IKEA has announced that it will not change its plan to cut prices and has enough inventory to deal with any supply chain shocks. As long as a large number of companies refrain from raising prices, this disruption will not affect consumer price inflation.

Can European policy makers easily overcome this issue?

The answer to this question is negative. The longer this disruption lasts, the more damage it will cause to companies and the economy. The American electric car company Tesla plans to stop most of the production at its German factory from January 29 to February 11 due to a lack of parts. Sweden’s Volvo shut down production at its Belgian plant for three days last month.

The impact of these developments on imports will be greater than on exports. About a quarter of the goods that enter Europe by sea are from Asia, and the share of this route in Europe’s exports is only 10%. Using the International Monetary Fund’s estimate of the impact of the increase in freight costs, the Oxford Economic Institute estimated on January 4 that the growth of container shipping costs would add 0.6 percent to inflation in a year. The European Central Bank expects euro zone inflation to slow to 2.7 percent this year, compared to 5.4 percent in 2023.

The Oxford Economic note states: “While this suggests that a sustained closure of the Red Sea wouldn’t prevent inflation from falling, it would slow the speed at which it returns to normal.”

In the long term, the situation may encourage companies to advance plans for more predictable alternative supply routes that were designed after business was disrupted by the coronavirus pandemic, according to a Reuters report. This can include longer but safer trade routes and close outsourcing or shifting outsourcing to bring production closer to important markets. But whatever the options, probably the common denominator of all of them will be higher costs.