The war in the Middle East is beginning to derail the global economy. The impact of the conflict will depend on its duration and scale, but economists are increasingly concerned about a generalized increase in prices and a weakening of growth.
“The macroeconomic transmission channel that affects everything”
The war, now entering its third week, has caused a near-paralysis of the Strait of Hormuz, through which a fifth of the world’s crude oil and liquefied natural gas passes, raising the specter of a new oil shock.
Oil prices rose on Tuesday to around $100 per barrel. Strategic energy installations in the Middle East are experiencing new attacks, and major economies have begun tapping into their strategic reserves.
“The longer this conflict persists, the more it begins to resemble a classic energy shock that directly impacts inflation,” explains Stephen Innes, a manager at the investment company SPI AM, in a written response to AFP.
“Oil is the macroeconomic transmission channel that affects everything, from freight to food and household energy bills,” he adds. “Higher energy prices act as a burden on consumers and businesses.”
Stagflation
“Before the outbreak of the war,” notes BNP Paribas’s deputy chief economist, Hélène Baudchon, “we expected sustained growth and rather less inflation.” The hostilities have reversed these expectations, she explains, citing the threat of stagflation: less growth and more inflation.
“But by how much? At this stage, there is no certainty,” as it will depend on “the duration and scale of the conflict,” notes the economist. BNP Paribas has maintained its growth forecasts for the United States (2.9%), China (4.7%), and the eurozone (1.6%).
Two stagflation scenarios are being considered, according to Hélène Baudchon. One involving a waning conflict intensity and a gradual retreat in hydrocarbon prices, which would remain above their pre-conflict levels, would be “manageable for the global economy,” which has been relatively resilient despite the recent rise in U.S. tariffs.
The scenario of a surge in oil prices over several weeks or months is “more negative” and could compel central banks to raise interest rates to curb price hikes. “The longer the blockage (of the Strait of Hormuz) lasts, the more products and raw materials it will affect, and the more disruptive the supply chains become, leading to inflationary effects that are not limited to oil and gas prices,” explains the economist.
Like after Covid?
According to Fitch Ratings, oil prices remaining at $100 per barrel would reduce the global GDP by 0.4% over four quarters and add “between 1.2 and 1.5 percentage points to inflation in Europe and the United States.”
This prospect could reignite fears of a new inflationary shock, after the post-Covid recovery and the beginning of the war in Ukraine in 2022, even though the current context is vastly different. Demand was very dynamic then, supply constrained by disruptions in supply chains, and fiscal policies generous.
The U.S. Federal Reserve on Wednesday, followed by the European Central Bank (ECB) and the Bank of England (BoE) on Thursday, are expected to maintain the status quo. But their comments on the current situation will be carefully examined, especially as the Reserve Bank of Australia raised its benchmark interest rate on Tuesday to cope with the “sharp rise in fuel prices,” becoming one of the first major monetary institutions to respond to the conflict.
“Traditionally, these external shocks are considered temporary. But many central bankers still have in mind the post-Covid recovery period,” points out Philippe Dauba-Pantanacce, head of geopolitical economic research at Standard Chartered, to AFP.
Central banks had long been hesitant to intervene in what they considered temporary shocks, but whose impact ended up being prolonged.
