Geopolitics breaks into the dynamics of the economy again, and it does so through its most sensitive aspect, that is, inflation. A 2024 was expected without major turbulence in terms of prices, facilitating convergence towards levels close to the ECB’s objective at the end of the year, this being a favorable terrain for the long-awaited relaxation of monetary policy.
The most recent data were consistent with this benevolent scenario: December closed with a flat CPI, compared to the increases that usually prevail in the Christmas period. The moderation of the shopping basket was also strengthened, thanks to the slight reduction in food prices (one tenth of a percentage point less in the month, cutting the interannual rate to 6.7%, far from the double digit supported by families until the fall ). On the other hand, disinflation has spread: one in every three components of the CPI, double that of last January, already has an inflation rate of less than 2%. Conversely, inflation exceeds 6% for one in four components, half that at the beginning of 2023.
Beyond the monthly ups and downs, the trend was favorable, given the increase of less than 2% observed in the fourth quarter as a whole (in terms of an annualized quarterly rate). As the trajectory has been the same in the eurozone, the possibility of a reduction in interest rates during the coming months was considered.
However, the risk of the conflict between Israel and Palestine spilling over throws cold water on this encouraging outlook. Given the intensification of Houthi attacks on merchant ships circulating through the Red Sea, the military reaction of a coalition of countries led by the United States has not been long in coming and threatens to provoke retaliation from Iran and other allies of the Shiite militias. The result is a paralysis of navigation in a strategic area for the world economy through which between 10% and 20% of world merchandise trade passes.
It is estimated that, in its attempt to bypass this region, transport between Asia and Europe suffers between two and three weeks of delay, which results in a sharp increase in costs. According to the Freightos price index, freight rates for that route have skyrocketed by 242% in the last two months. This is a magnitude that, if prolonged over time, is likely to interrupt the disinflation process: according to IMF estimates based on past experience, doubling the cost of transportation generates an increase in the CPI of six tenths.
Fortunately, the oversupply of containers is a mitigating factor. Given the weakness of global trade, demand is approximately 20% lower than the supply of containers, an imbalance that can mitigate the impact of increased transport times—but not cancel it.
The hostilities also threaten to destabilize energy markets. As some of the countries involved are large exporters of hydrocarbons, prices have begun to suffer and the price of a barrel of Brent has already risen above $80. The impact is still manageable, but much will depend on the evolution of the conflagration and its extent.
However, based on the hypothesis of a conflict concentrated in time, the de-escalation of the CPI should continue. The partial reversal of the VAT cuts and other taxes implemented after the war in Ukraine will have specific effects, but without breaking the path of disinflation. However, in a scenario of increased geopolitical tensions, prices will eventually react, with the double disadvantage of eroding the battered purchasing power of households and constraining the ECB’s room for maneuver to reduce interest rates. The economy, again on the wire.
Fossil energies continue to be one of the main Achilles heels of disinflation. Based on the hypothesis of a stable oil price around its current levels, an increase in the CPI of 3.2% is expected for 2024 as a whole, three tenths less than last year. For its part, the underlying CPI (discounting energy and fresh food) would fall to 2.9%, less than half that of 2023. In a scenario in which the price of oil rises to $100, the rate Average annual inflation would be 3.7%, and underlying inflation would be 3.3%.
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