IMF warns of global risks of widening war in Middle East

An escalating Middle East conflict risks leading to higher oil prices, a reversal of the fall in inflation and a puncturing of the optimistic mood in financial markets, the International Monetary Fund warned yesterday.

The Washington-based IMF said it was closely monitoring events in the region after Iran’s missile strike on Israel at the weekend and stressed the possibility that a war between the two countries could lead to higher interest rates.

Senior IMF officials used the launches of two important reports – the World Economic Outlook (WEO) and the Global Financial Stability Review (GFSR) – to highlight the risks that a broader conflict would pose at a time when financial markets assume there will be a soft landing for the global economy comprising lower inflation, falling interest rates and the avoidance of recession.

In London, anxiety over the crisis in the Middle East, and concerns that central banks will not cut interest rates soon, drove UK shares lower.

Previous wars in the Middle East have led to a sharp increase in oil prices and Pierre-Olivier Gourinchas, the IMF’s economic counsellor, said the fund was evaluating the possibility of another commodity shock.

He said: “The increased inflation that would come from higher energy prices would trigger a response from central banks that would tighten interest rates in order to secure inflation coming back to target, and that would weigh down on activity.

It would do so in a context in which in some countries activity and growth is already fairly weak, so that might also have a strong effect there.”

Gourinchas said the impact of a 15% rise in oil prices and higher shipping costs resulting from a conflict that was not contained would lead to a 0.7% rise in inflation, and damage business confidence and investment.

Tobias Adrian, the IMF’s financial counsellor, said at the release of the stability review that it was “very concerned” about the situation.

Adrian said there had been a fall in share prices even before Iran launched its strikes on Israel, and while oil prices were stable now there was a risk that they could rise.

He added: “In such a scenario that leads to upward pressure on inflation. Our key message to central banks is to make sure inflation is durably back to target and not to cut interest rates prematurely.”

Adrian used a blog accompanying the release of the GFSR report to caution financial markets against assuming there would be no fresh setbacks after the series of shocks to the global economy in recent years.

He wrote: “A sense of optimism has pervaded financial markets in recent months amid investor confidence that the fight against inflation is entering its ‘last mile’ and that central banks will ease monetary policy in the coming months. Stock markets around the world have risen substantially this year.”

However, he said geopolitical tensions could weigh on sentiment.

The concerns over the Middle East hit markets in London yesterday. The FTSE 100 closed down 145 points, or 1.8%, at 7,820 – the biggest drop in points since 6 July 2023. The fall marked a three-week low and a significant change in sentiment since Friday, when the index almost hit its record high of 8,047 points.

Adrian said there had been evidence from some countries that the trend to lower inflation had stalled..

In its WEO report, the IMF said Britain’s households would endure a second year without an improvement in living standards in 2024 as the effects of high inflation took time to abate. Growth per head – a key measure of living standards – was expected to remain flat.