Global economy resilient in face of Middle East war

The International Monetary Fund has offered a cautiously reassuring verdict on an unsettled world: the global economy, bruised by renewed conflict in the Gulf and an attendant jolt to energy prices, has proved more resistant than many policymakers feared. Yet the Fund’s latest numbers, published against the backdrop of fresh US strikes on Iranian tankers and a fraying ceasefire, carry the unmistakable flavour of a forecast written in pencil. Its baseline rests on one crucial assumption, that shipping through the Strait of Hormuz resumes by mid-July. If that corridor remains impaired, the world’s apparent steadiness could give way to a more familiar pattern of higher prices, weaker growth and a tightening of financial conditions.

The IMF’s interim update, its first since a tentative ceasefire was reached in June, raises the projection for global growth in 2027 even as it trims expectations for this year. That combination speaks to the Fund’s view of the shock: painful, inflationary, but not yet structurally damaging. Global GDP growth is now put at 3 per cent for the current year, slightly below the 3.1 per cent pencilled in April and still below the 3.5 per cent average recorded over 2024 and 2025. For 2027, however, the Fund has lifted its forecast to 3.4 per cent, up from 3.2 per cent in April. In a world in which geopolitics can close a sea lane overnight, the IMF is effectively arguing that the medium-term engine has not stalled.

Part of that confidence rests on a judgment that the first half of the year has been characterised by two offsetting forces. On one side sits the traditional channel through which conflict in the Middle East hits the world economy: higher oil and commodity prices, friction in supply chains, and a rise in risk premia across markets. On the other is a surge of optimism around the technology cycle, with advances in artificial intelligence and its rapid adoption bolstering demand, investment and, crucially, investor confidence. The IMF describes this as “accelerated demand-driven momentum” in the global tech cycle, a phrase that attempts to pin down a phenomenon markets have been trading on for months: that AI is not merely a speculative theme, but a force capable of cushioning a geopolitical blow.

That cushioning has limits, and the Fund is careful not to mistake the market mood for a durable solution. It does not claim that AI has magically immunised economies against energy shocks. Rather, it argues that strong momentum in technology has helped prevent the war from producing the kind of synchronised downturn that might once have followed a sharp rise in oil prices. The implication is that this cycle is doing more than lifting equity indices; it is pulling forward capital spending and activity in those regions most exposed to the technology upturn, notably the United States and parts of Asia. That said, the IMF’s own warnings about “AI hype and exuberant financial markets” underline a deeper ambivalence: the same enthusiasm that props up growth can also inflate the conditions for a destabilising correction.

The timing of the update underscores the IMF’s dilemma. Its forecasts were published within hours of Washington resuming strikes on Iranian tankers and President Trump declaring that the peace agreement allowing oil and gas to transit Hormuz was over. The Fund closed its forecast on June 10, before the later memorandum of understanding between the US and Iran was announced, and well before the latest exchange of blows. In other words, the IMF is reporting what the world looked like at a particular moment, and then appending an explicit caveat that the moment may already have passed.

Energy prices have, unsurprisingly, become the hinge of the story. Oil climbed to a three-week high of about $78 a barrel after the renewed strikes and the US move to revoke a licence that had allowed the sale of Iranian oil under the earlier understanding. The IMF estimates that average energy prices remain 25 per cent higher than before the war. It now expects average oil prices to be around $89 a barrel this year, 9 per cent higher than assumed in April. That is not a doomsday figure by historical standards, but it is high enough, and persistent enough, to complicate central banks’ efforts to tame inflation without crushing demand.

This is where the Fund’s assessment becomes most pointed. Progress on disinflation, it says, has “stalled” this year due to higher energy costs. Across economies, that stall matters less for the headline than for the choices it forces on policymakers. A world in which inflation stops falling is a world in which interest rates stay higher for longer, which in turn tightens credit, restrains investment and raises the risk that a modest slowdown becomes something more enduring. The IMF’s revised inflation numbers convey that tension. It expects average annual consumer prices to rise from 4.1 per cent in 2025 to 4.7 per cent this year, an unwelcome reminder that geopolitical shocks often arrive just as central banks think they have regained control.

Even so, the IMF maintains that many advanced economies, including the UK, are on course to reach 2 per cent inflation targets in 2027 for the first time in six years. That claim will read to some as hopeful rather than assured. Yet it reflects a belief that the current inflation impulse, while serious, is not necessarily self-reinforcing in the way it was when energy shocks met supply bottlenecks and tight labour markets earlier in the decade. The IMF is, in effect, betting that wage and price-setting behaviour has not shifted permanently, and that once the immediate energy impact fades, the underlying disinflation trend can resume.

The UK sits in an awkward but not entirely bleak position within that framework. The Fund’s projections leave Britain’s growth outlook unchanged from the estimates made in May: 1 per cent this year and 1.3 per cent in 2027. In a normal economic climate, those numbers would hardly invite celebration. Yet relative performance matters in the G7, particularly for a country trying to persuade investors that political stability has returned and that its long-term growth constraints can be eased. The IMF’s ranking places the UK as the third-fastest growing G7 economy this year, behind the US at 2.3 per cent and Canada at 1.1 per cent, and ahead of Germany, France and Italy. Spain, in the IMF’s telling, remains Europe’s standout performer, with growth of 2.1 per cent.

It is tempting for any chancellor to seize on relative league tables, and Rachel Reeves has done so, arguing that the forecasts show Britain has “the right economic plan” to deal with the costs of the war while “kickstarting long-term growth” through boosting AI, driving regional growth and strengthening trade with the EU. The politics are obvious, but the economics are more complicated. If Britain is indeed less exposed than feared to the Gulf shock, that is as much about its post-pandemic energy adjustments and the global nature of its services-heavy economy as it is about any single plan. The Fund’s own analysis suggests that the principal channels of pain remain external: higher energy prices and tighter global financial conditions. Domestic policy can mitigate those pressures at the margin, but it cannot make them disappear.

For investors and policymakers alike, the IMF’s baseline assumption on Hormuz is the crux. Shipping through the strait is not merely a regional concern; it is a pressure valve for the global energy system. The IMF states plainly that the most imminent risk to its forecast stems from developments in the Middle East and that a re-escalation would hurt growth while compounding inflationary pressures. Put differently, the world can absorb an oil shock that is brief and partially offset by strong demand elsewhere. It is less likely to absorb a prolonged disruption that forces businesses to reprice energy inputs, reroute logistics, and re-evaluate investment plans while households face another squeeze.

The update also reveals something about the structure of the global economy in 2026. The Fund notes that the modest slowdown reflects the war’s effects being partly offset by technology-led demand. That is a reminder that the global cycle has become more bifurcated: some sectors and regions are being propelled by a capital-deepening wave centred on AI, while others remain constrained by weak productivity, demographic pressure, and the lingering costs of a higher-rate environment. In such a landscape, resilience is not evenly distributed. It is possible for the aggregate number to look stable even as particular economies, industries or income groups feel acute strain.

There is also an uncomfortable feedback loop between the IMF’s two big themes, geopolitical risk and market exuberance. Conflict can trigger sudden repricing, but so can a collapse in confidence around the technology story. The IMF’s warning that AI hype and exuberant markets could sow the seeds of macro-financial instability is not incidental. In recent months, financial conditions have been eased by optimism, by rising equity valuations and by the sense that productivity gains might be closer than previously assumed. If those expectations prove too generous, or if leverage has built up around them, the world could face a shock from within the financial system at the same time as it absorbs shocks from geopolitics.

This is not the first time the IMF has been forced to balance reassurance with admonition. Yet the tone of the latest update suggests a particular concern that markets are treating geopolitical events as tradable noise rather than as structural risk. To be fair, the world has learned to live with a procession of crises. Supply chains have become more adaptable, energy markets more flexible, and governments more willing to intervene. But a sequence of manageable shocks can still produce a cumulative effect, especially if the cost is paid through persistently higher inflation and the long-term drag of elevated interest rates.

One reason the IMF’s analysis carries weight is that it arrives as the institution itself undergoes a change in intellectual leadership. Silvana Tenreyro, the former Bank of England rate-setter, will become the IMF’s chief economist later this year. Tenreyro, an Argentinian, Italian and British citizen, served as an external member of the Bank’s monetary policy committee from 2017 to 2023 and is now a professor at the London School of Economics. She succeeds Pierre Olivier-Gourinchas, who is returning to academia. Tenreyro takes the post at a moment when the Fund’s research is under scrutiny from the Trump administration, which has criticised it for being insufficiently tough on China’s trade imbalances.

The appointment matters not only because the chief economist shapes the IMF’s analytical priorities, but because the Fund’s credibility rests on its ability to call risks plainly. The IMF must persuade governments and markets that it is not simply reporting what is comfortable. Kristalina Georgieva, the managing director, praised Tenreyro as a globally respected economist who combines academic achievement with policymaking experience and engagement with international institutions. That combination will be tested quickly. The immediate question is how the Fund should think about an oil shock intersecting with a technology boom. The broader question is how it should advise governments facing a world where geopolitical ruptures can arrive faster than monetary policy can respond.

The headline message from the IMF is that the world economy has, so far, weathered the shock better than feared. That phrase, “so far”, does a great deal of work. It recognises that resilience is a temporal claim, not a permanent condition. A short disruption that lifts oil prices and then fades may leave only a scar. A protracted conflict that keeps energy expensive, squeezes real incomes and delays the return of inflation to target would reshape the policy landscape. The Fund is also alive to the possibility that the reopening of Hormuz could go more smoothly than assumed and that commodity prices could end up lower than in the baseline, raising growth and lowering inflation. But that is the nature of the moment: a forecast balanced on competing scenarios, each one plausible, each one dependent on decisions made far from central bank meeting rooms.

In the meantime, governments will try to claim vindication where they can, markets will attempt to price the unpriceable, and central bankers will watch energy futures as closely as wage data. The IMF’s numbers are, at best, a map of a landscape that is still shifting. Its most valuable contribution may be less the precise decimal points than the hierarchy of risks: renewed conflict in the Middle East as the nearest threat to growth and disinflation, and a frothy technology-driven financial cycle as a potential amplifier if confidence turns.

For an institution whose purpose is to warn before crises become unavoidable, that is a familiar and uncomfortable place to stand: acknowledging that the world has held together, while listing the reasons it might not do so for much longer.