The outbreak of military conflict in the Middle East may leave central bankers battling new inflationary trends as well as deal a blow to economic confidence at a time when they had expressed growing hope about containing the price surge sparked by the pandemic and Russia’s 2022 invasion of Ukraine.
Global Instability Resurfaces
The stunning violence in Israel, with hundreds killed as fighters from the Hamas movement invaded from their Gaza enclave and Israel responded in force, added the possibility of a broader Middle East conflict to the sense of global instability sparked by Russian military actions almost 20 months ago. The impact may take time to become clear and would depend on how long the conflict lasts, how intense it becomes, and whether it spreads to other parts of the region.
Immediate Implications
“It’s too early to say” what the implications may be. However, oil and equity markets may see immediate fallout, Agustin Carstens, general manager of the Bank for International Settlements, said in a presentation to the National Association for Business Economics. But the war has the potential at least to add an unpredictable set of forces to a global economy that was already slowing and to U.S. markets still adapting to the likelihood that the Federal Reserve will maintain high interest rates longer than many investors had expected.
Concerns for Economic Health
That and related issues will likely vault high on the agenda of global financial leaders gathering this week in Morocco for meetings of the International Monetary Fund and World Bank to take stock of a global economy that remains in a deep state of flux from the pandemic and rising trade tensions. For central banks, it poses the dilemma of whether it is likely to lead to new inflation pressures – the region is not just home to major oil producers like Iran and Saudi Arabia, but also to major shipping lanes through the Gulf of Suez – or deal such a blow to confidence that the economy stutters.
Fed’s Dilemma
Federal Reserve officials have cited recent high energy prices as a possible risk to their outlook of gradually easing inflation. They also said that they felt the U.S. economy was likely to avoid a recession – absent some sort of unexpected, outside shock. With the conflict now raging in a major oil-producing region, the reaction among traders and major players like Iran and Saudi Arabia will be watched closely to see if another price surge is coming, while trading on bond and stock markets in the coming days will show how markets anticipate the likely fallout.
Balancing Inflation and Growth
“The conflict poses a risk of higher oil prices, and risks to both inflation and the growth outlook,” said Karim Basta, chief economist at III Capital Management, leaving the Fed to sort out whether higher prices or slower growth is the greater concern. Fed officials were already watching a recent rise in U.S. Treasury bond yields for signs investors may have pushed financial conditions beyond what was needed to cool inflation and raised the risk of a too-stark economic slowing.
Seeking Stability
To the extent the Israeli war with Hamas heightens concerns about the global economy, it could reverse that trend if capital rushes towards the relative safety of U.S. Treasury bonds, as often happens at times of potential crisis. While falling market interest rates might, under other circumstances, be seen as a possible source of renewed inflation, encouraging consumers and businesses to borrow and spend, the context might lead to a different conclusion with emphasis on the perceived risks to the economy of a new regional war.
The Middle East conflict injects fresh uncertainties into an already fragile global economic scenario, with central banks closely monitoring for potential inflationary pressures and the overall impact on economic confidence. The outcome of this crisis will undoubtedly play a pivotal role in shaping the trajectory of the world economy in the months to come.
