How a regional conflict could unsettle global growth and inflation

George Alogoskoufis

The latest escalation of conflict in the Middle East is a reminder that geopolitics remains one of the most powerful forces shaping the global economy. Even in an era of digitalisation, financial globalisation and complex supply chains, the world economy still depends heavily on a relatively small number of strategic regions. Few are as consequential as the Middle East, a region that sits astride key energy reserves and maritime trade routes.

For the moment, financial markets appear cautious but not panicked. Oil prices have risen, shipping insurance costs have increased, and investors have moved modestly toward safe-haven assets such as gold and the dollar. Yet markets have not reacted with the dramatic swings seen during earlier geopolitical shocks. The explanation is simple: much depends on how far the conflict spreads and whether it disrupts the region’s vital energy infrastructure and global shipping.

Energy remains the most immediate channel through which the conflict can affect the global economy. The Middle East still accounts for roughly a third of global oil exports, and an even larger share of the world’s spare production capacity. Even more crucially, a significant portion of global energy flows through a narrow maritime corridor—the Strait of Hormuz—through which roughly a fifth of the world’s traded oil passes. Any disruption to shipping in this area would immediately reverberate through global energy markets.

A sustained rise in oil prices would have well known macroeconomic consequences. Higher energy prices raise production costs across the economy, from transport and manufacturing to agriculture and services. These cost increases are eventually passed on to consumers, raising inflation and eroding real incomes. For central banks already struggling to bring inflation back to target after the shocks of the pandemic and the war in Ukraine, a renewed energy shock would complicate the task considerably.

Yet the global economy is more resilient to oil shocks than it was in the past. Compared with the 1970s, advanced economies today are less energy-intensive. Energy efficiency has improved significantly, and many economies have diversified their energy sources. Moreover, strategic petroleum reserves and flexible global energy markets provide buffers that did not exist half a century ago.

Nevertheless, resilience does not mean immunity. A prolonged surge in oil prices could still produce a combination of slower growth and higher inflation—a familiar and uncomfortable economic condition often described as stagflation. Energy-importing economies, particularly in Europe and Asia, would feel the impact most acutely. Countries such as Japan, India and many emerging economies remain highly sensitive to energy price shocks.

Europe’s vulnerability is especially notable. Although the continent has significantly reduced its dependence on Russian energy following the invasion of Ukraine, it remains heavily reliant on imported fossil fuels. A sustained increase in global energy prices would therefore place renewed pressure on European households and industries. It could also slow the fragile recovery of the euro-area economy, which has only recently begun to emerge from the slowdown of the past two years.

Beyond energy markets, the conflict also threatens global trade through its impact on maritime transport. The Middle East lies along several of the world’s most important shipping routes. The Red Sea and the Suez Canal form a vital corridor linking Europe and Asia, while the Persian Gulf connects some of the world’s largest energy exporters with global markets.

If insecurity spreads to these routes, shipping costs could rise sharply. Insurance premiums for vessels operating in conflict zones tend to increase rapidly, while shipping companies may reroute vessels to avoid danger. Such diversions add time and expense to global supply chains. The rerouting of ships around Africa’s Cape of Good Hope, for example, can add weeks to voyages between Asia and Europe.

These disruptions would not merely affect energy markets. They could also reignite the supply-chain problems that plagued the global economy during the pandemic. Higher freight costs and longer delivery times could push up prices for a wide range of goods, from consumer electronics to industrial components.

Financial markets would also feel the consequences of a prolonged conflict. Geopolitical uncertainty typically leads investors to demand higher risk premiums. Equity markets often fall, particularly in sectors sensitive to global trade and economic growth, while safe-haven assets such as gold, the US dollar and US government bonds become more attractive.

At the same time, the conflict could produce winners as well as losers. Higher energy prices would boost revenues for oil-producing countries outside the immediate conflict zone, including the United States, Norway and Canada. American shale producers in particular could benefit from higher global prices, although the speed with which production can increase is constrained by both financial and logistical limitations.

More broadly, the conflict may accelerate several longer-term structural trends already shaping the global economy. One is the growing emphasis on energy security. Governments around the world are increasingly concerned about the vulnerability of global energy supply chains. This concern has already encouraged greater investment in renewable energy, nuclear power and alternative fuels.

Another trend is the gradual fragmentation of the global economy along geopolitical lines. Repeated geopolitical shocks—from the US-China trade tensions to the war in Ukraine—have encouraged governments and corporations to diversify supply chains and reduce dependence on potentially unstable regions. A prolonged Middle Eastern conflict could reinforce this trend, pushing firms to rethink the geography of global production and trade.

History offers both warnings and reassurances. The oil shocks of the 1970s demonstrate how geopolitical crises in the Middle East can trigger global recessions and profound economic disruption. Yet more recent conflicts in the region have often had more limited economic consequences, particularly when energy production and shipping routes remained largely intact.

The ultimate economic impact of the current conflict will therefore depend on three key factors. The first is its duration: short conflicts tend to produce temporary market volatility rather than lasting economic damage. The second is its geographic scope: a localised confrontation has very different implications from a broader regional war. The third—and most important—is whether energy production and shipping through the Gulf are significantly disrupted.

For now, the global economy remains watchful rather than alarmed. But the situation illustrates a broader truth: despite decades of globalisation and technological change, the world economy remains deeply intertwined with geopolitics. In the Middle East, as elsewhere, political instability can quickly translate into economic uncertainty.

In an increasingly fragile global landscape, the line between regional conflict and global economic shock remains thinner than many policymakers would like to believe.