As central banks continue to grapple with the economic fallout from the coronavirus pandemic and the Russia-Ukraine conflict, conflict in the Middle East could pose new risks to the global economic outlook. Central banks may have to contend with renewed inflationary pressures.
Israel and Palestine 7 broke out a new round of military conflict, Hamas launched a military operation against Israel on the same day, the Israeli army launched multiple rounds of air strikes on the Gaza Strip. The conflict is still ongoing. So far, more than 1,100 people have been killed in the latest round of fighting.
The prospect of a wider conflict in the Middle East could exacerbate the global instability triggered by the Russian-Ukrainian conflict nearly 20 months ago, disrupting supply chains and dragging down global economic confidence.
The economic impact of the conflict will depend on its duration and intensity, and whether it spreads to other parts of the Middle East, which is home to major oil producers such as Iran and Saudi Arabia and major international shipping lanes such as the Strait of Hormuz.
Agustin Carstens, managing director of the Bank for International Settlements (BIS), said in a speech to the National Association for Business Economics (NABE) that it was "too early to say" what impact the conflict in the Middle East might have on the economy, although oil and stock markets could be affected immediately.
Carl Tannenbaum, chief economist at Northern Trust, said any source of economic uncertainty delays decisions and increases risk premiums, especially given the importance of oil in the Middle East. He added that markets would be watching "what happens in the future" and whether this conflict ends differently after decades of instability in the Middle East.
The Fed is in trouble
As the conflict rages in the Middle East's key oil-producing region, the reaction of major producers such as Iran and Saudi Arabia will be closely watched to see if oil prices continue to surge. International oil prices surged in early Asian trading on Monday, with WTI crude up more than 4% at one point.
Analysts said crude prices could rise in the short term due to a possible knock-on effect on Iranian oil exports, but the overall impact of the geopolitical event on the oil market should be limited.
These risks could put the Fed in a difficult position, complicating future rate hike decisions. The Fed is considering whether to raise rates once more this year and weighing how long to keep rates high.
Fed officials have said that recent high energy prices could pose a risk to the gradually slowing inflation outlook and have said that, barring some kind of unexpected external shock, they believe the U.S. economy could avoid a recession.
Higher oil prices could add to inflationary pressures and undermine consumer confidence in the economy, threatening the Fed's hope-for outlook for a "soft landing" for the economy.
Karim Basta, chief economist at Ill Capital Management, said the conflict poses a risk of higher oil prices, as well as the outlook for inflation and economic growth. That leaves the Fed to figure out whether rising prices or slowing economic growth are the bigger concern.