UK economic consequences from Red Sea disruption

Key Judgments:

1. It is likely that negative market sentiment will drive inflationary pressures in the next 12 months. (High confidence).
2. It is likely that the Bank of England will not cut interest rates in the next 12 months. (Low confidence).
3. It is highly likely that the UK GDP will not grow in the next 12 months. (Low confidence).

Interest rates

UK interest rates starting from August 2023 to March 2024 have been set to 5.25%, the highest since the 2008 financial crisis. The inflation rate, as a result of these high interest rates, has dropped from 10% in November of 2022, to 4% as of Jan 2024, which means the high interest rates served their purpose effectively. This drop in inflation has resulted in the prospect of easing interest rates by the Bank of England. Assuming continued disruption in the Red Sea, which appears to be almost certain, a shift of market sentiment will highly likely occur, as well real economic disruption, which are likely to reignite inflationary pressures. Additionally, the government will have to commit more resources to defense and rearmament. With these sustained inflationary pressures on the UK market, it is likely that the Bank of England will keep interest rates high to continue to battle these pressures. It is worth noting that interest rates are determined by many more factors than a singular disruptive event, and thus the Bank of England may still opt to decrease interest rates for other reasons in the next 12 months.

GDP

Of the UK’s £3.1 trillion GDP, £1.74 trillion of this was as a result of trade in 2023. UK exports to countries affected by the Red Sea shipping lane make up an estimated £128 billion, and imports from these countries amount to roughly £120 billion. Sustained disruption of up to £250 billion in trade is likely to affect the ability of the UK to expand its industries. The manufacturing sector has already been impacted, with a reading from the S&P Global composite PMI highlighting a three-month drop to 44.9 for manufacturing output. A reading above 50 indicates growth, and below 50 indicates shrinkage. Given that the UK’s industrial sector makes up 20% of its GDP and has already begun to feel the impacts of the disruption in the Red Sea, it is likely that continued disruption will affect the UK’s ability to grow its GDP.

Escalation

Furthermore, the Houthis announced on 14 March 2024 that they are set to expand their operations, now aiming to prevent Israeli-linked ships from passing through the Indian Ocean towards the Cape of Good Hope, the only remaining supply route aside from the Red Sea between Europe and Asia. Whilst the claim is that its targets will be Israeli ships, this was also the claim in the Red Sea, wherein all ships, regardless of ownership or destination, were targeted by missiles. We can infer then that UK owned or operated vessels will be at high risk even whilst attempting to circumvent the Red Sea, further exacerbating the issues of inflationary pressure and strain on GDP growth mentioned above.

Summary

Assuming that the Houthis continue to disrupt commercial shipping in the Red Sea and successfully expand to the Indian Ocean, the economic consequences on the UK would be felt rather quickly by the population. Effects on the manufacturing sector to name one, as well as up to £250 billion of trade with Middle Eastern and Asian countries, are likely to affect the UK’s ability to grow its GDP. Negative market sentiment due to the uncertainty of disruption and conflict is a driving factor for inflation, which will further impede the UK’s ability to grow its GDP due to the likelihood of the Bank of England maintaining high interest rates.