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The impact of the deadly and unpredictable conflict in the Middle East on the global economy will be felt most immediately, and keenly, through the rising cost of oil.
Prices jumped on Monday, as markets had their first opportunity to digest the weekend’s tit-for-tat attacks. A barrel of Brent crude oil was trading at about $79 (£59) by lunchtime in London, up about $6 or 8.5% on the day.
The price had already risen significantly this year, from just above $60 in January, as tensions between the US and Iran intensified. Natural gas prices have shot up too, with the waterway also a vital artery for liquid national gas supplies. Benchmark European gas prices were up 38% on Monday, exacerbated after QatarEnergy said it was halting production at sites after drone attacks.
As the economic impact of Russia’s invasion of Ukraine underlined, rising energy costs feed through rapidly to consumers’ pockets – and have wider knock-on effects for the cost of just about everything else.
Net energy importers in Asia and Europe, including the UK, will be hit harder by higher prices. The US, with its shale oil supplies and strategic petroleum reserve, should be more able to insulate itself – though a prolonged spell of higher costs could deter the Federal Reserve from delivering the interest rate cuts Donald Trump dearly wants.
How high energy prices may go will depend on the scale of disruption to traffic through the crucial supply route of the strait of Hormuz, as well as the risk of direct attacks on energy infrastructure in the wider region. State-owned QatarEnergy announced that it was halting production at two sites on Monday, after attacks on facilities nearby.
Tankers are already declining to use the strait of Hormuz, which carries about 20% of global oil supplies – with insurers, perhaps not surprisingly, reluctant to provide cover. Some reports on Monday suggested ships are dodging the Suez canal too, as conflict engulfs the wider region. That could push up shipping costs for other goods besides crude.
Economists at Goldman Sachs suggest that in a worst case scenario, in which the strait of Hormuz was completely blocked for a month, oil prices would jump by as much as an additional $15 a barrel – though that could be partly mitigated by ramping up supplies via other routes. The Opec+ producers’ cartel has already signalled a modest increase in quotas.
This fresh spike in oil prices comes at a challenging time for policymakers, just as many felt they had finally vanquished the dramatic rise in inflation that followed the restarting of supply chains after the Covid pandemic and Russia’s invasion of Ukraine.
Central bankers typically “look through” short-term supply shocks such as a temporary surge in the oil price; but some – including the Bank of England in the UK – remain concerned about elevated inflation expectations.
The odds of a rate cut at the Bank’s next meeting on 19 March fell on Monday morning to 69%, from about 80% last week, amid the risk of a fresh tick upwards in prices.
Aside from the effects of costlier oil, economies in the Middle East – including Dubai for example – that have sold themselves as attractive destinations for tourism and global business may struggle to maintain that brand after news footage of Iranian attacks beamed worldwide.
But surveying the damage on Monday morning, economists said the vital question for the world economy was whether oil prices rise further – and how long that lasts.
“The duration of the shock matters as much as its magnitude,” said Neil Shearing, chief economist at consultancy Capital Economics. “If prices retrace over the next few months – either because the conflict de-escalates or because producers increase output to offset any disruption – then the impact on inflation in developed markets is likely to be modest and short-lived.”
If oil prices shoot up to $90-100 a barrel and stay there, however, inflation in developed markets would be up to 0.8% higher than expected, central banks could find themselves forced to start raising interest rates once more, and consumers would be squeezed, putting the brakes on growth.
That is certainly not a scenario Trump wants to see, but few would bet on this unpredictable conflict being neatly wrapped up soon.
