The International Monetary Fund warned that an escalating Middle East war could lead to higher oil costs, a reversal in the recent drop in inflation, and a dampening of the optimism on the financial markets.
The Washington-based IMF has said that it is closely monitoring the events in the area after Iran’s rocket strike on Israel over the weekend. It also stressed the possibility of a war between two countries leading to higher interest rates.
IMF officials have used the launch of two reports, the World Economic Outlook and the Global Financial Stability Review to highlight the dangers of a wider conflict at a moment when the financial markets are assuming that there will be an economic soft landing with lower inflation and falling interest rates.
London shares fell on the back of fears over the Middle East Crisis and central bank interest rate cuts.
The IMF’s Economic Counsellor, Pierre-Olivier Gourinchas said that the fund is evaluating the likelihood of a new commodity shock in the Middle East.
Gourinchas stated: “The increased inflation that would result from higher energy costs would trigger a reaction from central banks who would tighten the interest rates to ensure that inflation returns to its target and would weigh down activity.
It would have a significant impact in countries where activity and growth are already weak.
Gourinchas stated that the effect of a 15% increase in oil prices, as well as the increased shipping costs due to an uncontained conflict would result in a 0.7% inflation rise and also harm business confidence and investments.
Tobias Adrian said, “We are very worried about the developments in the Middle East.”
Adrian stated that the share prices had fallen even before Iran launched their missile attacks on Israel. While oil prices have remained stable, there is still a possibility of a rise.
Adrian stated that “in such a scenario, it leads to an upward pressure on the inflation.” “Higher rates of interest could be a factor again. “Our key message to the central banks is that they should not cut interest rates too early and instead ensure inflation returns to target.”
Adrian wrote a blog to accompany the release of GFSR, warning financial markets not to assume there wouldn’t be any new setbacks following the series of shocks that hit the global economy over the past few years.
Investors are confident that the fight against the inflation has entered its “last mile” and that central bankers will ease their monetary policies in the next few months. The stock markets have increased substantially around the globe this year.”
He said that there would “likely be bumps on this last mile”, and that geopolitical tensions might “weigh” investor sentiment.
Tuesday, the London financial markets were impacted by concerns about tensions in Middle East. The FTSE 100 fell 145 points or 1.8% to 7820, the largest drop since 6 July 2023.
The index fell to a new low of 3,047 points, a dramatic change from 12 April, when it almost reached its all-time high.
Adrian said that some countries, including the US, had shown that the trend toward lower inflation has stalled. The “last-mile narrative” could be challenged by readings that are higher than expected, which may lead to a revaluation of financial assets.
Andrew Bailey, Governor of the Bank of England, expressed his confidence that the UK would lower interest rates in spite of recent events in Middle East. Bailey, in an interview with Washington’s Washington Post, said that the UK is “disinflating” at full employment.
He said: There is solid evidence that the process is moving forward. We judge interest rates by how much we have to see in order to be confident.
The IMF stated in the WEO Report that Britain’s households will endure a second consecutive year without any improvement in living standards by 2024, as it would take some time for the effects of the high inflation to subside.
The report stated that growth per head, one of the most important measures of living standard, was expected to be flat this year following a 0.3% decline in 2023.