Fears about the global economy have been stoked by the rise in the price of oil to more than $100 a barrel as a result of the US-Israel war against Iran.
Economists say the growing likelihood of a protracted conflict in the vital energy-exporting region could have serious consequences for living standards around the world amid the threat of a new inflationary shock.
In a highly uncertain environment, financial markets are under strong selling pressure, consumers face rising prices, central banks could be forced to increase borrowing costs and governments will be under pressure to support households and businesses.
How high could the price of oil go?
Oil prices surpassed $119 a barrel on Monday, the highest level since Russia’s full-scale invasion of Ukraine in February 2022. Analysts say the continued closure of the Strait of Hormuz could push the price close to $150 a barrel, above the all-time high of $145.29 set in July 2008.
The narrow sea route on Iran’s southern border carries a fifth of seaborne crude oil and liquefied natural gas and a third of most widely used fertilizers.
Goldman Sachs has said Iran’s effective blockade of the waterway has had a 17 times greater impact than the April 2022 peak on Russian oil production after the invasion of Ukraine, which sent the price of oil to around $139 a barrel.
What happens next depends on how long the strait is effectively closed and the ability to divert exports. Saudi Arabia has started shipping crude to its Red Sea ports, but most exporters are stuck behind bottlenecks. As a result, Gulf oil and gas storage facilities are reaching their limits, meaning large oil fields may need to be shut down. Returning production to previous levels would take time, further aggravating the energy crisis.
Analysts say a short, sharp conflict that would allow Hormuz exports to resume would help cool energy prices. However, prolonged uncertainty could persist over the safety of the waterway. Capital Economics has said a longer conflict could keep the price of oil above $100 a barrel this year.
How much could inflation be affected?
The rising price of oil comes at a delicate time for the global economy. Central banks were nearing the end of a process of normalizing interest rates after the most aggressive tightening cycle in decades in response to the Russian invasion of Ukraine. Further rate cuts had been anticipated, but experts say the conflict with Iran could cause the opposite: a new rise in borrowing costs.
After the experience of 2022, it is well known how higher energy costs and logistics bottlenecks influence consumer prices. Fuel prices for motorists are already rising, household energy bills could rise sharply, and higher costs for businesses will spill over into global supply chains. These costs will ultimately be passed on to consumers.
There are hopes that a repeat of the inflation spikes of the 1970s, when oil price shocks from the Middle East hit the global economy, can be avoided.
Analysts highlight the fact that long-term inflation expectations have remained relatively strong in recent years, even after Russia’s invasion of Ukraine, suggesting that central banks have helped maintain confidence that prices can come back under control.
“The global economy is less sensitive to energy shocks than it was half a century ago,” said Jim Reid of Deutsche Bank. “Today, economies consume much less energy and labor markets have much less unionization and wage indexation, reducing the risk of a 1970s-style wage-price spiral.”
Could the crisis trigger a global recession?
Inflation surges caused by the Covid pandemic and the Russian invasion of Ukraine mean that households and businesses have already endured years of sharp price increases. Many are at the limit.
Economists say a new burst of inflation would hurt consumer demand and hurt economic activity. Fears of stagflation, where growth stagnates but inflation rises, are rising.
“There is talk of recession again,” said Ian Stewart, chief economist at accounting firm Deloitte in the United Kingdom.
“Rising oil and gas prices are harbingers of economic trouble. Higher energy prices, caused by war or revolution in the Middle East, were important factors in the Western recessions in 1973, 1979 and 1990. Rising energy prices in the wake of the Russian invasion of Ukraine collapsed Europe’s growth rate in 2023.”
Higher borrowing costs and heightened geopolitical uncertainty are likely to hit business investment and global trade, meaning countries whose growth prospects are already fragile could edge closer to recession.
How might governments respond?
G7 countries have said they are willing to release emergency oil reserves to ease concerns about global supply. Having increased domestic production in recent years, the United States is largely energy independent despite having depleted its domestic strategic oil reserve. China has accumulated huge oil reserves. European countries are likely to be hit hardest by the fallout. Most are net energy importers and rely heavily on oil and gas.
Governments will come under renewed pressure to increase their energy security. Much of the focus will be on accelerating the shift to a low-carbon economy and investment in renewable energy. However, a political battle over the pace of the transition is also likely, as occurred after the Russian invasion of Ukraine.
Politicians are also facing calls to provide emergency financial support to help struggling households and businesses with higher energy bills. EU countries and the UK intervened with costly plans four years ago.
However, borrowing and debt levels are already at breaking point for many Western governments, limiting the ability to implement costly new programs without testing the fragile appetite of the global bond market.
“The issue now is how much this will cost governments as energy support packages are floated as ideas,” said Jordan Rochester of Japanese bank Mizuho.
“This may be a war, but it is also perhaps the biggest logistics and energy supply crisis we have ever seen in modern history.”
