Will Middle East war blow up in ation?
Iran’s unprecedented attack on Israel at the weekend has further “ratcheted up tensions in the oil-rich Middle East”, says Anna Cooban for CNN. Oil prices have risen more than 18% so far this year to $90 a barrel, though the latest strikes had already been priced in and had a “muted” impact in trading on Monday.
The nightmare scenario for energy markets is one where conflict escalates and Iran targets shipping through the Strait of Hormuz, the narrow waterway that accounts for more than 25% of the world’s seaborne oil trade. Hormuz is “the main or only route” for the major Middle Eastern oil exporters, says Richard Bronze of Energy Aspects. “It is the most significant choke point in the global oil market.”
For now, oil remains well below the 2022 peaks it hit following Russia’s invasion of Ukraine, says Stanley Reed in The New York Times. Last year, high oil production in the US calmed the market, but 2024 has brought stronger demand than expected and disruption in the Middle East and Russia, where Ukraine is using drones to target oil infrastructure.
A “significant escalation” might send prices back towards their $120-a-barrel high of 2022, says Jennifer McKeown of Capital Economics. That would be sufficient to add about a percentage point to headline inflation in developed economies by the end of the year. That said, the risks of such a major disruption are still “quite low”. As “things stand, higher oil prices will boost inflation in advanced economies by only a few tenths of a percentage point in the months ahead”. Indeed, the latest rally could even encourage the Opec+ cartel to “dial back its production cuts”, seeing Brent crude “ease back” to $75 a barrel by the end of the year.
Inflation is America’s problem
The latest data shows inflation falling across developed countries, with annual price rises dropping to 3.2% in the UK and 2.4% in the euro area last month. However, the US saw inflation accelerate to 3.5%. That marked the third month in a row that US consumer prices surprised to the upside, says Samy Chaar of Lombard Odier. Globally, inflation “has been undershooting expectations this year” as things normalise after 2022’s energy-price shocks. The “US is very much the outlier”. Unlike elsewhere, its inflation problem comes not from supply constraints, but from strong demand that is overheating the economy. During the pandemic, the US government gave more financial support to households which then translated into stronger consumer spending.
“The big economic story of 2023” was the almost miraculous way that US inflation fell “even as growth remained resilient”, says The Economist. Perhaps that was “too good to be true”. While growth is still solid, inflation is starting to look “sticky” in the world’s largest economy. At the turn of the year investors were expecting six or seven interest-rate cuts in the US in 2024. But it’s now possible there will be none at all before the presidential election in November. For investors, that means that “monetary policy will almost certainly remain tighter for longer”. Stockmarkets could be in for a bumpy ride.