Red Sea disruption will hit Europe’s economy if it continues for months

While several weeks of attacks by the Houthi militia on vessels in the Red Sea and now the Gulf of Aden have disrupted shipping in the Suez Canal, the impacts of this have yet to be felt in the European and US economies.

Of the pair, the European economy is more vulnerable because it is already experiencing something of a mild recession, and exports from Asia cannot come via the Pacific, as they can for much of the USA.

However, one of the things learned from Covid was that paper-thin margins of error when it came to stock control were not as good idea as might previously have been thought. The mantra of “just-in-time” supply chains was another example of there being no such thing as a free lunch. While it generated small increases in profit margins, any supply chain shock could seriously hit profits for the year. That was what Covid brought, and as a result companies have tended to hold higher stock levels in 2023 than they had held in 2019.

But higher stock levels can only take a company so far, and if the disruption is prolonged, and if the restricted throughput at the Panama Canal continues, the economic outlooks for both Europe and the US will be slightly lower in 2024 than they would otherwise have been.

Ocean supply chain advisory firm Sea-Intelligence has warned that the disruptions to shipping from the Houthi attacks were already more damaging to the supply chain impact than the early Covid-19 pandemic.

Data showed that the longer transit around the Cape of Good Hope as ships divert from the Red Sea was already having a more significant impact on vessels available to pick up containers at ports than during the pandemic. “The vessel capacity drop is the second largest in recent years” said Alan Murphy, CEO of Sea-Intelligence. “The only single event with a bigger impact than the Red Sea crisis was the ‘Ever Given’. With that exception the Red Sea crisis was “the largest single event – even larger than the early pandemic impact,” Murphy said.

Both Germany and the UK have said that the impact of the situation so far had been negligible, but both also said that they were keeping a close eye on developments.

Another reason that the beginnings of impact on supply were not yet feeding through to macroeconomic data is that western economies are now performing at something under 100% capacity – the result of an 18-month sequence of rate hikes in the west that, while not causing a massive recession as some had feared, had certainly cooled down the economy to a noticeable degree. Under certain circumstances, a Suez Canal dispute might be expected to send oil prices higher, but the world, and Europe in particular, depends less on oil than it did, and the war in Ukraine has led to greater self-sufficiency. With supplies of oil remaining steady and demand still soft, there has been no “oil price shock” and neither is there likely to be one.

There had been concerns that the disruption to supply chains could feed through to inflation, but despite a few companies warning of disruptions, the hard fact for many retailers is that it will be difficult to maintain their margins in a market where demand for discretionary goods is soft. In 2023 they tended to get margins higher, so that could be where the sacrifices will be made.

Poundland owner Pepco Group’s executive chairman Andy Bond told Reuters last week that “our best forecast at the minute is we’re able to absorb the incremental cost that we estimate will come through”. International furniture retailer IKEA said that it would stick to planned price cuts. It also said that it had the stocks to absorb any supply chain shocks – possibly a result of softer than expected demand in H2 2023.

Nevertheless, Oxford Economics said at the start of the year that increases in container transport prices would add 0.6pp to inflation, but 12 months down the line. That would serve to reduce the expected gains in falling inflation this year to be less than hoped and predicted. In the EU euro area that would see the predicted fall from 5.4% to 2.7% look a rather less impressive fall from 5.4% to 3.3%.