Inflation figures dampen fears over Red Sea disruption

UK Inflation has fallen to its lowest level in almost two and a half years.

The rate of price rises dropped by more than expected last month to 3.4 per cent, according to new ONS data. Equally encouraging, the annual rate of inflation has slowed at its fastest rate since 1978 over the past 12 months.

The same factors that played a major role in causing prices to skyrocket are the ones now largely responsible for bringing inflation down: global food and energy costs. 

Energy costs are set to drop again at the start of April when the new domestic energy price cap kicks in, meaning the Bank of England is well on course to hit its big target of bringing inflation down to 2 per cent in April. 

Even so, today’s encouraging data is unlikely to persuade the Bank’s Monetary Policy Committee to start cutting interest rates when it reconvenes tomorrow. The MPC – which has foolishly overlooked Maggie Pagano’s columns for Reaction – is widely expected to vote to hold rates yet again, until at least June. 

Another takeaway from today’s inflation data is that fears that the sabotage of Red Sea shipping sabotage would cause another inflationary spike have not – at least yet – materialised. 

Attacks on container vessels, launched by Yemeni’s Houthi militants – allegedly in protest over Israel’s bombardment of Gaza – have been wreaking havoc on one of the world’s most important global trade routes for weeks.

Any disruption to the flow of goods through the Red Sea – a vital waterway connecting the Mediterranean and Indian Oceans – leads to delays, supply chain problems and increased costs for businesses around the world. Ships have been making expensive detours, around the southern tip of Africa, to avoid danger, adding thousand of miles onto their route, increasing fuel and insurance costs and charter fees. 

As a result, global shipping costs are up 90 percent compared to a year ago, with the average cost of a typical 40-foot container now standing at over $3,700, according to the Drewry World Container Index.

But these rising costs are not yet being passed onto UK consumers. The ONS said today that Houthi attacks have not caused inflation to spike because increased shipping costs are being offset by the sterling exchange rate which has increased for four months, improving Britain’s ability to pay for imports. 

It’s also important to place these rising shipping costs in wider context. The current crisis still pales in comparison to the scale of pandemic-induced supply chain disruption. 

As a recent Natwest report highlights, while shipping costs have shot up since the Red Sea attacks began, they’re still around 70 per cent below their post-pandemic highs.

Of course, it’s worth remembering that shipping contracts tend to be agreed in March for a fixed term (typically a year), meaning any impact of disruptions and costs of diversions will occur with a lag.

If attacks on ships do continue, could consumers, still recovering from a cost of living crunch, be hit with fresh price rises further down the line? 

Quite possibly. Though as Ross Walker, Natwest’s Chief UK Economist and Head of Global Economics, argues, even if shipping costs do persist and pressures intensify, the probability of these costs being absorbed at the early stages of production, rather than being passed onto consumers, is still a lot higher now than two years ago. 

During 2021, global demand for goods rose at an unprecedented speed and consumers were mostly stuck at home, many flush with savings, with little else to do but spend. Then post-pandemic reopening created a vast mismatch between pent-up demand for manufactured goods and heavily constrained supply chains.

In the current environment, global demand remains muted, with higher interest rates lowering consumers’ appetites, and producers and importers have higher profit margins to offset these steeper costs.

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