A sharp escalation in Gulf hostilities has reignited fears of global stagflation, shattering hopes that a recent interim agreement between the United States and Iran would shield the world economy from a combination of high inflation and stagnant growth.
With crude oil prices hitting the $100 mark and European gas prices recording their most significant monthly surge since March, government borrowing costs have climbed to multi-year highs as investors grapple with mounting inflation anxieties, reports Reuters.
The economic outlook is further clouded by intensifying trade frictions. On Friday, the US implemented new tariffs of 10 per cent and 12.5 per cent on goods from 60 trading partners, including China and the European Union, a move expected to apply further upward pressure on consumer prices.
Increased risk of stagflation
Alessia Berardi, head of global macroeconomics at the Amundi Investment Institute, noted that while stagflation risks have been present for every economy since March, the latest widening of the conflict “increases the risk of stagflation for sure”.
Energy remains the primary catalyst for near-term inflation expectations. Brent crude futures, which had dipped to $70 earlier in July amidst ceasefire optimism, touched $100 again after Yemen’s Houthis reported striking two Saudi oil tankers in the Red Sea.
This development has extended shipping disruptions beyond the Strait of Hormuz, a critical passage for approximately 20 per cent of the world’s liquefied natural gas (LNG) supply.
Oil prices have surged nearly 40 per cent in July, marking the steepest monthly increase since March, while benchmark European natural gas futures have reached their highest levels since the same period.
Commodity and food price pressure
The impact extends beyond fuel. Analytics firm Kpler estimates that roughly one-third of the world’s fertilisers pass through the Strait of Hormuz, suggesting food prices could remain elevated, particularly affecting vulnerable emerging markets. These pressures are being compounded by this year’s El Niño weather pattern.
In the US, June inflation figures were lower than anticipated, but the relief was short-lived. Rising energy costs have since driven up government bond yields across the US, Japan, and Germany.
Kristjan Kasikov, Citi’s head of FX quant investor solutions, warned that markets often lag in fully pricing the impact of volatility in agricultural and energy commodities.
Central bank response
Traders have resumed bets that central banks will be forced into further interest rate hikes. Markets now anticipate approximately two more quarter-point increases from the European Central Bank (ECB) by the end of the year.
Similarly, despite a brief easing of expectations, markets are now pricing in two US rate hikes by January, as inflation has exceeded the Federal Reserve’s 2 per cent target for five years.
Andrew Sheets, global head of fixed income research at Morgan Stanley, observed that the ECB appears more inclined than the Federal Reserve to raise rates in response to oil-driven inflation. He warned that Europe faces a “double hit”, with the economy squeezed by both higher energy costs and tighter monetary policy.
Global growth and regional impact
The growth-stifling aspect of stagflation is also becoming visible. The World Bank’s chief economist told Reuters that the conflict could potentially reduce global growth to as low as 1.3 per cent, down from 2.9 per cent last year.
Asia remains particularly vulnerable due to its heavy reliance on Gulf oil. In Japan, the value of imports reached a record high in June as the yen continues to languish at four-decade lows against the dollar.
The US is also feeling the strain, with average petrol prices returning to the “psychological threshold” of $4 a gallon. Furthermore, combined fuel expenses for four major US airlines were nearly $8 billion higher than a year ago, while mortgage rates have reached their highest level since last August.
