Market Update: We break down the business implications, market impact, and expert insights related to Market Update: Prepare for stagflation as war on Iran hits world economy – Full Analysis.
The risk of price increases combined with weaker economic growth compounds the longer the Middle East conflict continues.
Almost three weeks into the Middle East war, analysts fear a long, drawn-out conflict and disruption to oil trade could undermine the global economy.
Economists are contemplating a gloomy combination of prices rising across the board and growth stalling.
The conflict, which started late February with US and Israeli strikes on Iran, has seen oil traffic through the vital Strait of Hormuz chokepoint – through which a fifth of global crude and liquefied natural gas normally transits – come to a virtual standstill.
As a result, oil prices have spiked from around $60 before hostilities to current levels of around $100, after briefly touching $120.
Iran has responded to US and Israeli strikes by attacking strategic energy infrastructure across the region, leading major economies to begin dipping into their strategic oil reserves.
“The longer this conflict drags on, the more it begins to look like a classic energy shock feeding directly into inflation,” said Stephen Innes, managing partner for SPI Asset Management.
Oil is the macro transmission channel that touches everything from freight to food to household utility bills. So the first impact is inflation, but the second-order effect is on growth because higher energy prices act like a tax on consumers and businesses.
Stephen Innes, SPI Asset Management
Stagflation
“Before the war broke out, we expected steady growth and rather less inflation,” Helene Baudchon, deputy chief economist for BNP Paribas, told AFP.
Baudchon says the hostilities have flipped that benign scenario to concerns about so-called stagflation, where lower growth is accompanied by higher inflation.
“But how high? At this stage, there is no certainty; it will depend on the length and scope of the conflict,” she said.
For now, BNP Paribas is sticking with its growth forecast of 2.9% for 2025 for the US, 4.7% for China, and 1.6% for the eurozone.
For Baudchon, two stagflationary paths loom. In the first, the intensity of the conflict drops off, and hydrocarbon prices gradually decline while remaining above pre-conflict levels, which “would appear manageable for the global economy”. It has so far remained relatively resilient, even to increases in US tariffs.
However, a surge in oil prices lasting several weeks or months would be “more negative” and could force central banks to raise interest rates to curb rising consumer prices.
“The longer the [Hormuz] blockade lasts, the more products and raw materials it will affect, the more supply chains will be disrupted, and the more inflationary effects will be felt. They would not be limited to oil and gas prices,” says Baudchon.
Like post-Covid?
According to Fitch Ratings, oil prices holding at $100 per barrel would reduce global GDP by 0.4% after four quarters and add “between 1.2 and 1.5 percentage points to inflation in Europe and the United States”.
Such an outlook is liable to reignite fears of another inflationary shock after the one caused by the post-Covid recovery and the start of the war in Ukraine in 2022, even if today’s context is very different.
At that time, demand was strong, supply chains were disrupted, and fiscal policies were accommodative.
Several key central banks will meet this week – the US Federal Reserve on Wednesday, and the European Central Bank and the Bank of England on Thursday. They are expected to keep their rates steady, but their comments on the current situation will be closely scrutinised.
Australia raised its key interest rate by a quarter-point on Tuesday to address a “sharp rise in fuel prices”, becoming one of the first major central banks to respond to the conflict with a hike.
“Markets are starting to take that risk seriously,” said Innes.
Philippe Dauba-Pantanacce, senior economist at Standard Chartered Bank, recalled that authorities initially underestimated the inflationary impact of the Covid recovery.
“Traditionally, such external shocks are considered ‘temporary’ shocks, but many central bankers will have the Covid recovery period in mind as something that was deemed ‘transitory’ but ended up being more inflationary than anticipated, including on how it led to a gradual disanchoring of inflation expectations.”