Conflict in the Middle East increases risks to the global economy

Instability in the Middle East could push central banks into a new fight against inflation, when their efforts are only barely effective.

On October 7, the armed group Hamas attacked Israel , launching the largest military campaign against the country in decades. Israel retaliated with continuous air strikes on the Gaza Strip. Along with the Russia-Ukraine conflict, this development makes the world situation even more unstable.

Observers say that the impact from this may take a while to become clear. It also depends on how long the conflict lasts, how severe it is, and whether it spreads to other parts of the region.

"It's too early to talk about the potential impact," although oil and stock markets reacted immediately, said Agustin Carstens - Director of the Bank for International Settlements (BIS).

Brent and WTI oil prices this morning increased up to 5% at times . The US dollar and Japanese yen also strengthened compared to other currencies. The Israeli stock and bond market plummeted on October 8. A series of businesses in this country have also had to stop operations.

Smoke rises after an Israeli airstrike in Gaza on October 7. Photo: Reuters

Conflict in the Middle East can create new challenges for the global economy. World growth is already slowing down. The US market is also finding ways to adapt to the possibility that the Federal Reserve (US) maintains interest rates at high levels for longer than expected.

"Any economic instability can delay policy decisions of countries, increase risk costs and cause turmoil in the oil market. Markets are closely following developments. Current question is whether this situation will cause long-term imbalances," said Carl Tannenbaum - economist at Northern Trust.

This week, the International Monetary Fund (IMF) and the World Bank (WB) will meet to evaluate the global economy. The situation in the Middle East and related issues will likely be the focus of discussion among financial leaders. The world economy is still in constant fluctuation due to the pandemic and trade tensions over the past few years.

For central banks, the current situation continues to push them into a dilemma. They will have to consider whether the conflict in the Middle East will cause inflation to rise again or not. Because this region not only has major oil producing countries, such as Iran and Saudi Arabia, but also important shipping routes.

Fed officials said rising energy prices are a risk to the inflation outlook. In the latest meeting minutes, they said that the US economy can avoid recession, if there are no unexpected shocks from outside.

When conflict breaks out in the world's major oil-producing region, the reaction of traders and countries like Iran or Saudi Arabia will be closely watched to see if oil prices skyrocket. The next few days of stock and bond trading will also show what the markets are predicting as the outcome.

"This conflict could increase oil prices, increase inflation, and threaten growth prospects," said Karim Basta - chief economist at III Capital Management. The Fed will have to weigh whether high prices or slow growth is more worrying.

Fed officials are currently monitoring developments in the US government bond market. US government bond yields have recently gone up, meaning investors prefer to pour money into other channels with higher risk.

However, if developments in the Middle East increase concerns about the global economy, US government bonds will again be popular as investors seek shelter, leading to lower interest rates.

In other cases, falling interest rates are considered a positive signal, encouraging people and businesses to spend. But as such, it may imply that new risks to the global economy have emerged.