An inflation shock triggered by the US-Israel attack on Iran could wreck a fragile global economic recovery that had been expected to gain momentum this year.
With oil and gas prices spiking, despite a pledge from Donald Trump to protect tankers making their way through the crucial strait of Hormuz shipping chokepoint, central bankers and economists have warned that a prolonged conflict could increase retail prices around the world and force them to rip up growth forecasts for this year.
On Friday, the International Monetary Fund managing director, Kristalina Georgieva, said a 10% increase in energy prices that persists for a year would push up global inflation by 40 basis points and slow global economic growth by 0.1-0.2%.
“The world economy has been remarkably resilient. Shock after shock, and yet growth is at 3.3%,” Georgieva told Bloomberg.
Some economists argue that a jump in the price of energy and transport costs, significant though they are for households and businesses, could prove to be a sideshow if the bombing of Iran by the US and Israel destabilises financial markets already worried about ballooning AI stocks and the impact of US import tariffs.
“It’s not like this war has started with the world in a settled place,” said Lord Jim O’Neill, the ex-chief economist of Goldman Sachs Asset Management and former government adviser.
There are also analysts who worry about the chaos prompted by Iran’s retaliatory bombing of Kuwait, Dubai, Saudi Arabia and, most recently, Azerbaijan, which could trigger a further re-ordering of global strategic alliances – and not to the west’s benefit.
O’Neill, a crossbench peer, said the White House appeared to have given little consideration to the geopolitical impact of its opportunistic assassination of Ayatollah Ali Khamenei and subsequent bombing campaign.
“The Gulf states will be thinking the US is an unreliable partner and be drawn towards China, India and Brazil,” he said.
O’Neill became famous more than 20 years ago for coining the term Brics to denote the emerging economies of Brazil, Russia, India, China and South Africa, which was later expanded to include Iran and Saudi Arabia among a larger grouping of 11.
Saudi Arabia, the United Arab Emirates and Kuwait are among the countries to have had important infrastructure sites – airports, oil refineries and gas plants – targeted by Iranian rockets and drones.
If Iran takes aim at some of the 450-plus desalination plants that feed the region with fresh water, then social unrest could follow.
Oil is the key
About 20% of global oil supply passes through the strait of Hormuz. Drawing on academic studies and the experience of past supply disruption, Bloomberg Economics estimates that a 1% drop in supply pushes oil prices up by about 4%.
That suggests a closure of the strait over a few months would raise prices by 80% from pre-Iran war levels, taking them to about $108 a barrel.
Oxford Economics said it expected inflation at the end of the year in the UK and eurozone would be roughly 0.5 percentage points to 0.6 percentage points higher than previously expected. UK inflation was 3% in January, while in the eurozone it was 1.9% in February.
Economic growth will be hit
In the US, forecasts have remained unchanged, with economists pencilling in growth of 2.2% this year, as the cost of higher wholesale energy prices is offset by the huge gains to the US fracking companies that will benefit from bigger profits selling their home-drilled gas.
However, US consumers have already begun to feel direct financial pain after a 17% rise in Brent crude prices that has fed into fuel station prices, which tend to rise roughly 2.5 cents for every $1 increase per barrel on global markets.
Since last Saturday, prices at the pump have jumped by 15 cents a gallon on average across the US, according to the price tracker service GasBuddy.
Long term, disruptions in the global supply chain are likely to feed back to the US and push up costs that many Americans already believe are too high. Anger over the cost of living was a major factor in Joe Biden’s defeat. Now, Trump is struggling to convince Americans that he has the situation under control.
Trump’s nominee as the incoming chair of the Federal Reserve, Kevin Warsh, is expected to change the US central bank’s response to inflation. If he follows the president’s wishes, Warsh will cut interest rates when he takes over in May, even if inflation is increasing. Last week, financial markets assigned a 97% probability to the Fed holding rates steady at its meeting later this month, monitoring how the Iran conflict develops before taking any action.
UK and Europe will suffer
According to the National Institute of Economic and Social Research, a UK thinktank, economic growth in the UK and euro area could drop by 0.2% this year if the impact of the conflict persists. In the UK, that means national income, or gross domestic product (GDP), falling from a growth rate of 1.1% estimated by the Office for Budget Responsibility to 0.9%.
The projection for the euro area by the EU Commission would be cut from 1.2% to 1%. In the context of a long period of low growth, these falls will damage investment, push up interest rates and hurt government finances.
In the UK, diesel has risen 5p since the conflict began to 147p a litre – the most expensive since August 2024 – while petrol has risen by 3p to 136p on average, the RAC said.
That will place a further squeeze on households already grappling with the rising cost of essentials, which has become a political sore spot in the lead-up to both local elections in the UK in May and the US midterms in November.
Official polling released by the Office for National Statistics last month found that 88% of adults believed the cost of living was the most important issue facing Britain.
A recent poll by YouGov showed that roughly 42% of Americans believe the state of the US economy is poor, marking the highest level since September 2024. That has been compounded by anger over Trump’s tariff regime, with most Americans saying Trump’s tariffs have resulted in them having to pay more for goods and services, according to a separate YouGov poll.
Emphasising the vulnerability across Europe to higher imported gas and oil prices, three European Central Bank (ECB) policymakers warned on Thursday that eurozone inflation would probably rise, and growth sag, if the conflict in the Middle East becomes drawn out and sucks in more countries.
The ECB’s vice-president Luis de Guindos, and the central bank governors of Germany and Finland, all said it was too early to draw conclusions but warned that a prolonged, wider war may push up inflation, both present and expected.
De Guindos said: “The baseline (is) that this is going to be short-lived. If it is longer, then there is a risk that inflation expectations will change.”
The interest rate conundrum
In the UK, Bank of England ratesetter Alan Taylor said on Monday that central banks should reject raising interest rates to tackle an energy price shock that was imported from the Middle East and over which UK policymakers had little control.
Taylor is more concerned that high borrowing costs will make a difficult situation worse, hitting investment and pushing up unemployment from already high levels.
Taylor is likely to be in a minority after central bankers delayed interest rate rises in the wake of Russia’s invasion of Ukraine. Most central bank staff have since concluded that treating the situation as temporary was a mistake and they should have reacted more quickly to rising oil, gas and food costs.
Michael Saunders, senior economic adviser at Oxford Economics and a former central bank official, said he expected the Bank to hold rates at 3.75% at its next meeting and possibly for the remainder of this year if the conflict continued. In the days before the war erupted, financial markets expected at least two quarter-point cuts this year, to 3.25%.
UK mortgage lenders have already begun to increase the interest rate on home loans in a further blow to the living standards of hard-pressed households who cannot catch a break.
