The International Monetary Fund has cautioned that tensions in the Middle East pose a significant risk of escalating oil prices, reversing the recent decline in inflation, and dampening the upbeat sentiment in financial markets.
The IMF, headquartered in Washington, highlighted its close monitoring of the situation in the region following Iran’s missile strike on Israel over the weekend. It emphasized the potential for a conflict between the two nations to result in higher interest rates.
During the launch of two reports—the World Economic Outlook (WEO) and the Global Financial Stability Review (GFSR)—senior IMF officials underscored the threat of a broader conflict, which financial markets currently believe will lead to a smooth economic transition characterized by reduced inflation, declining interest rates, and recession avoidance.
In London, concerns over the Middle East crisis and doubts regarding imminent interest rate cuts by central banks contributed to a decline in UK shares.
Past conflicts in the Middle East have historically caused a significant spike in oil prices. Pierre-Olivier Gourinchas, the IMF’s economic advisor, stated that the organization is assessing the potential for another disruption in commodity markets from the region.
Gourinchas explained, “The anticipated rise in inflation due to increased energy costs would prompt central banks to adjust interest rates to stabilize inflation, which could hinder economic activity, especially in countries already experiencing weak growth.”
He further elaborated that a 15% surge in oil prices and elevated shipping expenses resulting from an uncontained conflict could lead to a 0.7% uptick in inflation and negatively impact business confidence and investment.
Tobias Adrian, the IMF’s financial advisor, expressed deep concern about developments in the Middle East during the release of the GFSR. He noted a decline in stock prices even before Iran’s missile strikes on Israel and highlighted the risk of oil price escalation.
Adrian cautioned, “Such a scenario would exert upward pressure on inflation, potentially prompting a return to higher interest rates. Our advice to central banks is to ensure that inflation remains consistently on target and to avoid premature interest rate cuts.”
He used a blog post accompanying the GFSR release to warn financial markets against assuming a smooth path forward, stressing that geopolitical tensions could impact investor confidence.
The apprehension over Middle East tensions reverberated through financial markets in London, with the FTSE 100 witnessing its largest point drop since July 6, 2023, closing down 145 points at 7820.
Adrian also highlighted evidence from certain countries, including the US, suggesting that the downward trend in inflation may have halted. Higher-than-anticipated inflation figures could challenge the prevailing narrative and lead to a reassessment of financial assets.
Bank of England Governor Andrew Bailey, speaking from Washington, expressed confidence in the UK’s progress towards lower interest rates despite recent events in the Middle East. He asserted that the UK was experiencing disinflation alongside full employment, indicating a positive trajectory for interest rates.
In the WEO report, the IMF projected that British households would face another year without improvements in living standards due to lingering effects of high inflation, with growth per head expected to remain stagnant after a slight decline in 2023.
