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No matter how long the Iran war goes on, the economy is bound to suffer from it. How much and how severely depends on just how long the conflict continues to crimp key energy exports. Some degree of inflation is now inevitable.
Energy prices won’t return to prewar levels, whenever peace returns. Too much damage has been done to the Persian Gulf’s infrastructure for pumping, refining and shipping oil and natural gas. Fuel prices will climb more if the war escalates, which is a real risk if Washington sends ground troops to secure parts of Iran’s coast or strategic islands.
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Gasoline, averaging $4/gallon, could hit $5 or more this summer if the fighting mounts. Diesel, already nearing its all-time record of $5.82/gallon, could average $6, jacking up freight shipping costs. Fertilizer shortages will weigh on farmers around the world who didn’t secure what they needed before the war halted the Gulf’s huge fertilizer exports. That bodes especially ill for the spring planting season in the Northern Hemisphere. This means pricier food.
These and other cost pressures could boost headline inflation to 4% or more later this year, vs. 2.4% in February. That’s if oil prices, now at $110/barrel, stay near $100 per barrel for an extended period of time. While there will be plenty of price volatility, $100 on average is a real possibility if the war drags on. With the Persian Gulf blocked, at least 10% of the world’s oil, plus a huge amount of natural gas, can’t get to market.
Even a quick resolution of the fighting wouldn’t avoid an inflationary bump. Restoring exports of oil, gas, fertilizer and other key commodities from the Middle East will take anywhere from weeks to years, depending on the extent of needed repairs. In the U.S., gas prices might retreat to $3.50 — still above the $3 on the eve of the war.
Higher inflation makes any Federal Reserve interest rate cuts highly unlikely. The Fed has been cautious so far about what the war could mean for the economy. But it has signaled that it is on guard against renewed inflation pressures and will act to tamp them down if needed. It doesn’t want a repeat of 2022, when prices soared.
The economy can still keep growing, even in the face of higher inflation sparked by the war’s disruptions. Recall that in 2022, when inflation peaked at 9%, GDP still grew 2.5%. Outright recession is unlikely, though we can’t rule it out entirely. In fact, the economy stands to benefit from the extra defense spending that will occur, especially at ammunition factories. Inflation is not likely to hit the highs of 2022, given that the economy is not as tight and the labor market has more slack now. With a resolution to the war, or at least when oil tanker traffic can start to flow again, the price of oil will start to fall. Even if prices do not return to their prewar levels, any drop should grease the wheels of economic activity and restore investor confidence.
Other sectors that stand to be affected by the Iran war:
- Petrochemicals: Up to $25 billion in shipments pass through the Strait of Hormuz annually. Led by Saudi Arabia, the Middle East accounts for 40% of global polyethylene exports, the world’s most common plastic, the price of which has jumped 37% since late February.
- Cars: Overall sales will slip by 3.0% on higher interest rates. Purchases of fuel-efficient hybrids are sure to keep soaring. Electric car sales may rise a bit, too.
- Domestic oil and gas producers and refiners stand to reap sizable benefits as they partially fill the void in energy markets left by missing Middle East exports. The U.S. being the world’s largest oil and gas producer is an invaluable asset now.
Note the rising risk that the unpredictability of the war will dampen confidence among consumers and businesses this year. That could cause consumers to save more and businesses to cancel spending plans, especially if the fighting drags on or escalates.
This forecast first appeared in The Kiplinger Letter, which has been running since 1923 and is a collection of concise weekly forecasts on business and economic trends, as well as what to expect from Washington, to help you understand what’s coming up to make the most of your investments and your money. Subscribe to The Kiplinger Letter.