Inflation, oil price surge put double shock on global economy

As the situation in the Middle East intensifies with Iran's first strike on Israel's mainland, there's a mounting apprehension about a potential 'double shock' scenario, which would entail a sharp rise in oil prices exacerbating the already critical levels of inflation.

With the resurgence of fears around the U.S. Federal Reserve's 'Higher for Longer' stance, which had momentarily subsided, the combination of escalating oil prices and geopolitical instability could steer the global economy toward a different trajectory characterized by stagflation rather than a soft landing. Stagflation refers to a scenario where prices surge while economic growth remains stagnant. On Friday (local time), as reports surfaced regarding Iran's impending attack on Israel, Austan Goolsbee, President of the U.S. Federal Reserve Bank of Chicago, voiced apprehension during a Fox News interview, saying that an escalation of the conflict in the Middle East will present a wildcard for the Federal Reserve.

Immediately after war broke out on Oct. 7 last year when Hamas, a Palestinian armed group supported by Iran, attacked Israel, international oil prices exceeded $90 per barrel. However, as Iran continued to engage in a ‘proxy war’ rather than direct participation in the war, it fell to the $70 range in early January of this year.

According to the U.S. Energy Information Administration (EIA), an average of 21 million barrels of oil transit through the Strait of Hormuz, a critical oil transport route, every day. This accounts for approximately 21% of the world's total oil production.

On the ICE Futures Europe, the price of Brent crude oil had already surged to $87 per barrel on April 1 following reports of the Israeli attack on the Iranian consulate in Syria. Subsequently, on Friday, when reports emerged of an imminent Iranian attack on mainland Israel, it spiked further to $92.18 during the day. On the same day, the price of West Texas Intermediate (WTI) crude oil May futures also climbed to $87.67 per barrel on the New York Mercantile Exchange.

What's different from 50 years ago is the emergence of the U.S. as a significant crude oil producer. Consequently, even if the worst-case scenario doesn't become reality, the fact that each country is embroiled in the final stages of an inflation battle could burden the economy. With the market already anticipating that the Fed's interest rate cut in June has been sidelined, there's a possibility of further delays in the rate cut due to the escalating conflict in the Middle East.


Hyoun-Soo Kim kimhs@donga.com