Traffic disruptions in the Red Sea may hinder the reduction of interest rates, warns the Bank of Latvia

Currently, sailing around southern Africa is a safe alternative with predictable costs and predictable delays. Demand, especially in the Eurozone, is also considered weak over the past year, which reduces the pressure on carriers. In addition, the level of inventories of eurozone companies is considered sufficient compared to historical levels, and companies have the opportunity to continue operating without significant disruptions for at least some time, the report of the Bank of Latvia explained.

While shipping costs typically make up a small portion of the final cost of imported goods, the observed increase in container charter prices has been significant enough to raise questions about the potential impact on inflation, especially given that tensions in the Red Sea affect about 15% of for all eurozone import goods.

In the opinion of the Bank of Latvia, the impact of the current tension on eurozone inflation can be assessed as moderate. However, as the situation drags on, for example until the middle of the year, the impact could already become much stronger.

There are mainly two reasons for this, explains the Bank of Latvia. First, as long-term ship charter prices remain at high levels, long-term shipping contracts would be increasingly renegotiated, thereby strengthening the pass-through of costs to store-shelf prices. Second, some of the impact of the tightening on inflation is currently being dampened by high levels of corporate inventories, which will eventually shrink and need to be replaced at higher costs.

Tensions in the Middle East continue to remain high, and it is difficult to say when the situation might return to normal. The longer this tension persists and ship traffic in the Red Sea is disrupted, the stronger the impact on inflation will be, according to the Bank of Latvia. Although euro zone inflation continues to decline and financial markets are already waiting for the first interest rate cuts, the disruption of Red Sea traffic may prove to be one of the factors that may hinder a more rapid end to restrictive monetary policy.