Key points:

  • The escalation of the conflict leads to rising oil prices due to concerns about potential supply disruptions.
  • In addition, the situation in the Middle East is fueling inflation and slowing economic growth.
  • In times of uncertainty, investors traditionally turn to the U.S. dollar as a safe-haven asset.

Despite the progress made in stabilizing the global economy and overcoming a period of high inflation without entering a recession, rising tensions in the Middle East introduce new elements of uncertainty to the global economic situation.

The escalation of the conflict between Israel and Hamas, accompanied by the Israeli army’s ground operation in Gaza, the expansion of hostilities into southern Lebanon, and bombings of Israel by Iran, has significantly worsened the regional situation.

Oil prices see steady growth

The recent escalation of the Middle East conflict has caused significant concern in global energy markets. Oil prices have shown a steady upward trend, driven by fears of potential disruptions to the supply of raw materials from the region. Investors believe that the expansion of military actions could lead to targeted attacks on Iran’s oil infrastructure, which in turn would provoke retaliatory measures from Tehran and further destabilize the situation.

Over the past week, WTI crude prices have risen by more than 10%, reaching their highest levels since August this year, surpassing $74 per barrel. Similarly, Brent crude prices have increased by nearly 9%, exceeding $78 per barrel.

It’s important to note that the current level of Brent crude, around $75 per barrel, is significantly lower than the peak levels reached last year following the outbreak of the conflict between Israel and Hamas ($84 per barrel).

European countries will be the most vulnerable to rising energy prices, as they heavily depend on oil imports. Even moderate oil price increases could have a substantial impact on inflation levels in European economies. According to experts, a sustained 10% increase in oil prices would lead to a 0.1 percentage point rise in inflation.

If a full-scale military conflict unfolds in the Middle East, accompanied by attacks on energy infrastructure and disruptions to trade routes through the Red Sea, the negative economic consequences would be far more severe. According to Oxford Economics analysts, such a scenario could cause oil prices to spike to $130 per barrel and slow global economic growth by 0.4 percentage points next year.

Inflation risks worsen

The armed conflict in the Middle East is escalating, threatening to turn into a regional war. Israel’s statements about being ready to retaliate against Iran following recent rocket attacks, triggered by the elimination of senior Hamas and Hezbollah leaders, significantly increase the risks of further escalation.

In light of these events, the global economy, already under pressure from slower growth due to rising interest rates, declining global trade volumes, and geopolitical uncertainty—including the upcoming U.S. presidential elections and China’s economic slowdown—faces the threat of new shocks.

According to Ahmet Kaya, chief economist at the National Institute of Economic and Social Research in the UK, the development of a full-scale military conflict in the Middle East could destabilize the global economy, heighten uncertainty among economic agents, derail efforts to reduce inflation, and ultimately slow the pace of global economic growth.

Kaya warns of the risk of accelerating inflation due to disruptions in international supply chains, rising energy and logistics costs. He notes that a $10 per barrel increase in oil prices could push inflation up by 0.4-0.6 percentage points in developed countries, while a 10% rise in shipping tariffs could boost inflation by about 0.3 percentage points.

How are central banks responding to the Middle East situation?

The escalation of geopolitical tensions in the Middle East, reflected in ballistic missile attacks on Israel, has had a noticeable impact on global currency markets. The U.S. dollar, traditionally seen by investors as a safe-haven asset during periods of heightened uncertainty, has strengthened. The dollar index, which tracks the currency’s value against a basket of major world currencies, reached three-week highs.

While central bankers emphasize the importance of focusing on fundamental economic processes and long-term trends, they can’t entirely ignore short-term geopolitical shocks. However, according to several high-ranking central bank representatives, the current Middle East conflict escalation doesn’t yet require significant adjustments to monetary policy.

For example, Bank of England Governor Andrew Bailey indicated the possibility of more aggressive rate cuts if inflationary pressures continue to ease. This suggests that central bankers aren’t yet viewing the Middle East conflict as a serious threat to price stability. Bailey also stressed the importance of maintaining stability in oil markets but warned that further conflict escalation could lead to higher energy prices.

A similar stance was expressed by Swedish Riksbank Deputy Governor Per Jansson, who stated that the current consequences of the Middle East conflict are insufficient to warrant a revision of economic forecasts.