A prolonged conflict in the Red Sea and escalating tensions across the Middle East risk having devastating effects on the global economy, reigniting inflation and disrupting energy supplies, some of the world’s leading economists warn this weekend.
Before a statement expected on Monday by Rishi Sunak in the House of Commons about UK and US airstrikes on Houthi sites in Yemen, economists at the World Bank say the crisis now threatens to feed through into higher interest rates, lower growth, persistent inflation and greater geopolitical uncertainty.
After a second night of strikes against the Iranian-backed rebels in Yemen, President Joe Biden said that the US had sent a private message to Tehran that “we’re confident we’re well prepared”. Speaking to reporters on the White House lawn on Saturday, on his way to Camp David, Biden declined to go into further detail.
But there is now growing concern in government circles in London and Washington that as Sunak and Biden fight for re-election, events in the Middle East could dash what had looked like improved prospects for economic recovery and therefore their chances at the ballot box.
While the airstrikes against Houthi targets in Yemen have broad cross-party support at Westminster, Sunak will face questions from anxious MPs about a prolonged conflict and the longer-term plan for Middle East peace. Some leftwing Labour MPs are expected to put Keir Starmer under pressure over why he backed the military strikes having said that he would only support such action after parliament had voted in favour of it.
Biden also faced pushback from progressives in his own party, already deeply opposed to US military support for Israeli action in Gaza. California congressman Ro Khanna said: “The president needs to come to Congress before launching a strike against the Houthis in Yemen and involving us in another Middle East conflict.”
In its latest report on global economic prospects, the World Bank says the Middle East crisis, with the war in Ukraine, has created real dangers. “Conflict escalation could lead to surging energy prices, with broader implications for global activity and inflation,” it says.
“Other risks include financial stress related to real interest rates, persistent inflation, weaker than expected growth in China, further trade fragmentation and climate change-related disasters.”
It adds: “Recent attacks on commercial vessels transiting the Red Sea have already started to disrupt key shipping routes, eroding slack in supply networks and increasing the likelihood of inflationary bottlenecks. In a setting of escalating conflicts, energy supplies could also be substantially disrupted, leading to a spike in energy prices. This would have significant spillovers to other commodity prices and heighten geopolitical and economic uncertainty, which in turn could dampen investment and lead to a further weakening of growth.”
John Llewellyn, a partner at Independent Economics and a former chief economist of the Organisation for Economic Co-operation and Development (OECD), said: “This has escalated to become a serious problem.” He put the probability of serious disruptions to world trade at 30%, up from 10% a week ago: “There is a horrible and inevitable progression that could see the situation in the Red Sea spread to the strait of Hormuz and the wider Middle East.”
An economist at the Institute for Fiscal Studies, Ben Zaranko, told the Observer the crisis underlined the perils of the chancellor, Jeremy Hunt, using limited fiscal headroom to promise tax cuts. “If we have learned anything over the last few years it is that bad shocks can and do come along,” Zaranko said. “Spending every single penny of ‘headroom’ on tax cuts leaves him no room for manoeuvre if a nasty shock comes along and the outlook deteriorates.”
The conflict in the Middle East widened on Thursday when dozens of British and US strikes hit Houthi sites in Yemen. The strikes were in retaliation for attacks on vessels passing through the Red Sea, which have paralysed shipping in one of the world’s most important maritime channels.
The Houthis say they are targeting only Israel-affiliated vessels, in an effort to support Palestinians in Gaza, but many of their targets had no known links to Israel. They have also fired missiles at Israel’s territory.
A US strike on a radar site in Yemen on Friday night prompted Houthi threats of a “strong and effective response” to international attacks, and fuelled fears of regional escalation in a conflict already playing out across multiple borders.
Houthi spokesperson Mohammed Abdulsalam said the strikes had had no significant impact on the Houthis’ ability to prevent vessels from passing through the Red Sea and the Arabian Sea.
The top UN official for Yemen, special envoy Hans Grundberg, warned of “serious concerns” about stability and the fragile peace efforts in Yemen, which has endured years of civil war.
The Houthis are just one of several Iran-aligned groups across the region, including in Syria, Iraq and Lebanon, which are attacking targets either inside Israel, or which they say are linked to Israel. Hezbollah in Lebanon represents perhaps the most severe threat.
Farea Al-Muslimi, from the Chatham House Middle East programme, said: “The Houthis are far more savvy, prepared and well-equipped than many western commentators realise. Their recklessness, and willingness to escalate in the face of a challenge, is always underrated.”
William Bain, the British Chamber of Commerce’s trade expert, said: “About 500,000 containers were going through the Suez canal in November and that had dropped 60% to 200,000 in December.”
Ships are taking different routes, but that has raised costs, with a container that cost $1,500 in November rising to $4,000 in December.
“If things get worse, it only adds to the disruption, and the cost of containers will go up and global trade will fall further,” he said.
Economists, many of them arriving in Davos this week for the annual World Economic Forum, have become increasingly worried that many of the world’s major economies may now suffer a recession this year. They fear that central banks will make only modest cuts to borrowing costs, adding to the cost of living crisis faced by millions of households.
The prospect of higher oil prices could convince central banks to hold firm and maintain high interest rates for a longer period than currently expected.
Liam Byrne, chair of the Commons business and trade select committee, said: “There’s now a real risk that a Red Sea battle will push up prices, just as inflation was beginning to fall. The World Bank is already warning that global supply chains are once more in peril … not least because this new struggle in Suez comes as drought is cutting trade through the Panama canal. Two of the world’s five keys to trade are now in real jeopardy.”
