Rising oil prices driven by the Iran strikes could trigger a fresh wave of global inflation.
Brent’s sharp rally, fuelled by escalating US military action against Iran, has injected fresh volatility into global markets, with Brent crude briefly topping above $82 a barrel in Asian trading before settling near $78, up about 7% on the session.
Energy Prices Reignite Central Bank Pressure
Investors are once again facing inflation concerns at a time when price growth in major economies is still above, or only just nearing, central bank targets.
As I was quoted by CNN, Investing.com, Gulf News, Oman Observer, The Herald Ghana, Trade Arabia, Business Money, IOL, National Business Review, and Business Tech, amongst others, when Brent rises this rapidly, the inflation outlook shifts quickly across developed markets.
The Bank of England calculates that a 10% rise in Brent crude prices usually pushes UK inflation up by about 0.2 to 0.3 percentage points.
The importance of that multiplier is being overlooked.
A prolonged increase of this size would significantly raise headline CPI in the UK.
Policymakers who thought inflation was steadily returning to target would come under renewed pressure.
UK inflation has remained above the Bank of England’s 2% target, with services inflation continuing to show resilience. An extra surge in energy prices could risk entrenching higher inflation expectations among consumers and businesses.
In the US, inflation is still highly responsive to fuel prices. Changes in gasoline costs directly influence consumer confidence and inflation expectations. If crude climbs toward $90 or $100, the impact on CPI would be difficult to avoid.
The Federal Reserve’s 2% inflation goal has guided its efforts to rein in the post-pandemic surge in prices, but disruptions in energy markets make that task more challenging.
Global Economies Remain Highly Exposed
Even though core inflation excludes food and energy, prolonged increases in oil prices typically filter through to transportation, shipping, production inputs, and eventually consumer prices.
Oil doesn’t function in isolation; higher freight costs, more expensive airline fuel, and rising distribution expenses follow. Companies either see profit margins shrink or pass costs on to consumers, and often both occur
Whereas in the euro area, the recent easing of headline inflation has been partly driven by lower energy prices
A reversal in energy trends could call into question the European Central Bank’s expectations for further policy easing
Europe is inherently more vulnerable to fluctuations in imported energy. Any disruption to Middle Eastern supply routes would strain the supply-demand balance and intensify price volatility. As a result, progress on reducing inflation across the bloc could slow or reverse.
Australia is similarly exposed. With inflation still above the Reserve Bank of Australia’s 2-3% target range, further energy price pressures could postpone expectations of monetary easing.
Australian households are already coping with high living costs, and fuel and transport expenses are especially noticeable. A sustained rise in crude prices would quickly be reflected in domestic inflation figures.
Markets Begin Pricing In Prolonged Risk
Beyond the direct impact on CPI, if companies expect ongoing increases in input costs, they may adjust prices in advance. Likewise, if employees anticipate higher living expenses, wage demands are likely to rise
Geopolitical escalation increases the risk of supply disruptions in the Strait of Hormuz, a key passageway that carries about one-fifth of global crude trade. Even if no physical blockage occurs, heightened military tensions typically widen risk premiums
Markets tend to price in risk before actual supply is affected.
As tensions rise, insurance premiums increase, shipping routes are adjusted, futures markets steepen, and volatility alone can help sustain higher benchmark prices.
Energy-led inflation reduces the scope for central banks to ease policy
If oil prices remain elevated, expectations for interest rate cuts would likely diminish.
Central banks cannot ignore an externally driven spike in prices. Monetary policy would stay restrictive for a longer period, which could dampen economic growth
Financial markets are starting to price in that possibility.
Stock markets can usually withstand short-term price spikes. But prolonged conflict alters the outlook. Corporate earnings projections are based on steady input costs. If crude stays high, analysts will need to revise their forecasts
Consequently, if oil prices continue to rise, inflation is likely to follow, putting central banks back in a defensive position.
To read my previous blog post, click here.