How the Current Middle East Crisis is Stoking Inflation and Negatively Impacting Growth
Once again, Benchmark Brent crude oil has surpassed the $100/bbl mark this month, stoking inflationary pressures globally – including across the UK, EU, and United States. Japan is concerned about inflation overshooting its 2.00% target, while price growth remains elevated in Australia and negative pressures persist across Southeast Asia. Sadly, the conflict between the US and Iran carries on unabated, with experts advising that tensions have reached a critical flashpoint with President Trump mulling over whether or not to begin devastating military action, and Iran promising unlimited retaliation and a continued blockade of the Strait of Hormuz.
The on-going war between Ukraine and Russia is putting further strain on global energy supplies, with experts warning that the autumn and winter may witness a serious supply shock with negative consequences to both global growth and inflation. However, since the invasion of Iran on the 28th February this year, and due to the unexpected resilience in the oil and gas trade, negative forecasts for global growth turned out to be incorrect. Indeed, thanks to a resilient global trading system, China’s pull-back from the crude market, the release of 400 million barrels from strategic reserves, and global preparations for energy shortages, crude oil prices ultimately held below previous record peaks.
Data released shows global growth on an annualised basis in Q2 of this year, growing at the same pace as Q1, (figures excluded the six members of the Gulf Cooperation Council*), with one expert also pointing to the huge investments in data storage and the boom in artificial intelligence (AI) being partially responsible. However, energy prices are finally making themselves felt, as on the 10th September, the ECB (European Central Bank) increased interest rates by 25 basis points, citing inflationary pressures and risks to the downside of economic growth. Elsewhere, and last week, both the Federal Reserve (first time since 2023) and the BOJ (Bank of Japan) increased interest rates by 25 basis points, both citing inflationary pressures due to the above mentioned conflict.
*Gulf Cooperation Council – This council consists of six members including Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates. Founded in Riyadh, Saudi Arabia on 25th May 1981, its purpose is a political and economic alliance focused on security, trade and social development.
Whilst the price of oil is considered to be an inflation barometer for the global economy, it is the price of refined fuels that have traditionally fed through to inflation. Since the start of the Middle East conflict, refined fuel markets, including diesel, petrol, and jet fuel, have been tighter than the crude oil market. This is mainly due to high shipping costs and a lack of adequate refining capacity. Indeed, due to the Ukraine/Russia conflict, Russian production (despite being the third largest refiner), is at its lowest for over twenty years as sustained drone attacks by Ukraine has cut production this year by circa 30%. This year, diesel surpassed the $200 p/bl mark in both Europe and the US, with consumers in the US seeing $6.00 per gallon for the first time in recorded history.
Many observers note that AI investment has sustained growth, but the narrative surrounding AI and the global economy has shifted dramatically. According to analysts, AI remains a pillar of economic activity, but fears of a major tech-driven slowdown have taken centre stage following unprecedented calls by senior financial officials and from the industry’s own leaders to cut back on development. In a rare show of unity, the CEO’s of Open AI, Microsoft and DeepMind called to slow the development of increasingly capable AI, as safety advocates warned of existential threats. Last week on September 14th, AI and semiconductor shares took a nosedive across global markets prompting debates as to whether the massive, debt-fuelled AI infrastructure boom was facing a structural downshift.
Experts suggest that a structural down shift within the AI arena, together with a prolonged energy shock emanating from the Middle East crisis, could severely cripple global economic expansion and risk a prolonged period of global stagflation. In today’s global economy, analysts advise that there is a tug-of-war between an energy supply shock – currently driven by the US/Iran conflict, the loss of the Saudi Arabian East/West Pipeline, the Strait of Hormuz blockade, and Houthi insurgent incursions on two strategic Red Sea islands – which is depressing economic growth. On the other hand, massive AI investment is a counter prevailing force. If the AI engine stalls while energy prices remain high, the global economy loses its cushion and growth could fall dramatically.
