Middle East Conflict Raises Stagflation Threat for Global Economy
New business surveys from around the world this week are set to deliver a worrying snapshot of the global economy. Analysts expect the data to show the escalating economic impact of seven weeks of conflict in the Middle East. This fresh geopolitical crisis is reviving fears of a dangerous economic condition known as stagflation.
Stagflation is a combination of stagnant economic growth and persistently high inflation. It is a nightmare scenario for central bankers because the typical tool to fight inflation—raising interest rates—can further slow growth and increase unemployment. The global economy has been grappling with high inflation for over two years, and growth has already been fragile.
Surveys to Show Widespread Deterioration
Initial data from major economies, from Australia to the United States, is anticipated to show a broad deterioration in business activity for November. The surveys, known as Purchasing Managers’ Indexes (PMIs), are closely watched leading indicators. They measure whether businesses are experiencing expansion or contraction.
Europe is seen as particularly vulnerable. The continent’s economy was already teetering on the edge of recession before the Hamas-Israel war began in October. The conflict has since driven a sharp spike in global oil and natural gas prices due to fears of a wider regional war that could disrupt energy supplies from the Middle East.
Energy Prices and Confidence Take a Hit
Higher energy costs act as a tax on consumers and increase production costs for companies worldwide. This directly fuels inflation. At the same time, the uncertainty from the war is causing businesses and consumers to pull back on spending and investment. This dual blow of higher prices and lower confidence is what creates the stagflation risk.
For example, a European manufacturer facing higher fuel and raw material costs may raise prices for its goods, contributing to inflation. If consumers, worried about the economic outlook, then decide not to buy those goods, the factory’s growth stalls. This pattern, repeated across economies, is what policymakers fear.
Central Banks in a Difficult Position
Policymakers at the US Federal Reserve, the European Central Bank, and other institutions are cautiously awaiting this week’s figures. The data will be critical for informing their upcoming decisions on interest rates. Their challenge is immense: they must decide whether to keep rates high to combat inflation or consider cutting them to support weakening growth.
A return of stagflation would severely limit their options. Cutting rates to help growth could cause inflation to surge again. Yet keeping rates restrictive could push the economy into a deeper downturn. This difficult balancing act has become even more complex due to the geopolitical shock in the Middle East.
Investors worldwide will be scrutinizing the survey results. The findings will shape market expectations for the timing of future interest rate moves and could trigger volatility in stocks, bonds, and currency markets. The data will reveal just how quickly the winds of war are translating into economic headwinds for the global economy.
