The outbreak of military conflict in the Middle East may force central bankers to confront new inflationary trends while also undermining economic confidence at a time when they had indicated increased optimism about limiting the price surge caused by the epidemic and Russia’s 2022 invasion of Ukraine.

The shocking violence in Israel, with hundreds killed as Hamas fighters invaded from their Gaza enclave and Israel responded with force, added the possibility of a larger Middle East conflict to the sense of global instability sparked by Russian military actions nearly 20 months ago.

The consequences may take some time to become obvious, depending on how long the war lasts, how intense it becomes, and whether it spreads to other regions of the region.

“It’s too early to say” what the implications may be, though 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.

However, the battle has the potential to add an unpredictable set of dynamics to a global economy that was already declining, as well as to US markets that are still adjusting to the possibility that the Federal Reserve would keep interest rates high for longer than many investors had anticipated.

“Any source of economic uncertainty delays decision-making, increases risk premia, and especially given that region…there is an apprehension about where oil is going to open,” said Carl Tannenbaum, chief economist with Northern Trust.

“The markets will also be following what the scenarios are looking like,” he said, and whether, after decades of instability in the Middle East, this outbreak of violence evolves differently.

“The question will be is this iteration something that will throw the long-term equilibrium out of balance?”

That and related concerns are likely to be high on the agenda of global financial officials meeting this week in Morocco for meetings of the International Monetary Fund and World Bank to assess the status of the global economy in the aftermath of the pandemic and escalating trade tensions.

For central banks, the decision is whether to expect additional inflationary pressures – the region is home not just to key oil producers such as Iran and Saudi Arabia, but also to vital shipping channels through the Gulf of Suez – or to inflict such a shock to confidence that the economy stalls.

Federal Reserve officials have identified recent high oil costs as a potential risk to their prognosis of gradually reducing inflation, and they have also stated that they believe the US economy would escape a recession unless there is an unanticipated, outside shock.

With conflict raging in a major oil-producing region, traders and major players such as Iran and Saudi Arabia will be closely watched to see if another price surge is on the way, while trading on bond and stock markets in the coming days will reveal how markets anticipate the likely fallout.

“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 policymakers were already on the lookout for evidence that investors had pushed financial conditions beyond what was required to lower inflation, raising the risk of an overly sluggish economy.

To the extent that Israel’s war with Hamas raises fears about the global economy, that tendency might be reversed if capital rushes to the relative safety of US Treasury bonds, as it regularly does in times of potential catastrophe.

While dropping market interest rates could be viewed as a potential source of renewed inflation, encouraging consumers and companies to borrow and spend, the context could lead to a different conclusion, with an emphasis on the perceived risks to the economy of a new regional war.

(Adapted from FoxBusiness.com)

Categories: Economy & Finance, Geopolitics, Regulations & Legal, Strategy, Uncategorized