The world economy survived the shocks of the Ukraine-Russia conflict, which has had limited impact on economic growth. But the escalation of hostilities in the Middle East has transformed what had been, until early 2026, a surprisingly benign outlook into a far more uncertain one. It has created the ultimate test for how resilient the world economy really is.
Amid stalled ceasefire negotiations, the US president, Donald Trump, has threatened a blockade of vessels transiting through Iranian ports in the strait of Hormuz. This sent oil prices back up over US$100 (£74) a barrel. Meanwhile the current ceasefire is looking very shaky.
The key economic factor in this conflict is straightforward: the near-halting of shipments through the strait and the closure of energy infrastructure.
These elements have disrupted roughly one-fifth of global oil production and nearly another 20% of the world’s trade in liquefied natural gas (LNG). With little spare capacity elsewhere, the result has been a sharp and rapid surge in energy prices.
Forecasts of price surges for benchmark oils
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This is a classic energy price shock. The consequences for the world economy are predictable in direction but uncertain in magnitude. The latest interim economic outlook from the Organisation for Economic Co-operation and Development (OECD) projects global GDP growth at 2.9% in 2026. This is almost unchanged from its forecast before the war started.
But the OECD report also highlights the conflict’s expected consequences: energy exporters gain from improved terms of trade, while importers – including most of Europe, Japan, Korea, and much of emerging Asia – face a squeeze on real incomes.
For example, US growth has been revised up by 0.3 percentage points (to 2%) while growth in the euro area and the UK have been revised down by 0.4 and 0.5 percentage points respectively.
When it comes to inflation, exporters and importers face similar cost increases. Inflation is expected to increase everywhere, with headline inflation in the group of G20 countries predicted to rise by 1.2 percentage points to 4%. The European Central Bank (ECB) has made similar predictions for growth and inflation.
But these estimates are based on specific (and possibly optimistic) assumptions about energy prices. In their baseline scenarios, energy prices are expected to peak below US$100 per barrel this quarter and begin falling gradually from the middle of the year – as priced in by oil futures markets.
And what about less benign scenarios such as a resumption of the conflict or Trump’s threatened blockade limiting traffic in the strait of Hormuz? Energy prices could stay higher for longer and would be unlikely to be eased by a temporary ceasefire.
The here and now
The most immediate impact of the war on the global economy has been a sharp shortage of distillate fuels, particularly gasoil and jet fuel. This disruption comes at a time of seasonally high demand, driven by agricultural planting and the approach of peak holiday travel, when air traffic typically rises.
Gulf oil producers are key suppliers of these fuels to Asian markets, leaving countries such as South Korea, Singapore, Taiwan and Australia especially vulnerable to supply constraints.
Compounding the problem, crude oil from the Gulf is particularly suited to producing jet fuel and diesel, and cannot easily be replaced by refining alternative grades of oil. As a result, distillate prices in affected markets have surged dramatically, in some cases rising by as much as 200%.
Further blockage of the strait will starve the global market of at least 10% of its demand. This would result in a “demand destruction” (the curtailment of demand for road and air travel in particular) that can only be achieved through raised prices.
If the war in Iran were to go on just for another couple of months, prices for Brent could reach US$120 per barrel. Six months of conflict could see prices exceed US$200 a barrel. This is because supply losses are cumulative – as commercial and strategic reserves are depleted, the supply risk increases.
Oil price projections if the hostilities continue
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The ECB’s March 2026 projections for the euro area incorporate some of these scenarios. For example, in what it calls an adverse scenario where oil prices peak at US$120 and decline slowly, economic growth in the euro area becomes negative for 2026.
And in its most pessimistic scenario, oil prices shoot even higher (US$140), which results in a deeper recession and inflation reaching more than 6%.
The last two scenarios are the perfect example of the stagflationary world that policymakers dread: contracting output and high inflation. In this environment, the levers that they have at their disposal are severely constrained.
Central banks face a classic dilemma: raising interest rates to contain inflation risks slowing growth even more. But cutting them to encourage spending and faster growth risks increasing prices at precisely the wrong moment. The ECB’s data-dependent, meeting-by-meeting approach is the right posture, but it offers no easy exits.
Fiscal policy faces its own challenges. Governments will be tempted to protect households and firms from higher energy costs, as they did after the 2022 energy crisis. Some targeted support for the most vulnerable would be legitimate and necessary, but broad subsidies that suppress energy prices send the wrong signal.
Countries that import energy have become poorer, and policies that negate this fact will only sustain energy demand at a time when the opposite approach is required. Put simply, everyone needs to be more efficient or use less energy. And let’s not forget that governments, because of high levels of debt, now have even less fiscal room to support the economy through this crisis. With no clear path out of the hostilities, the resilience of the global economy is facing a very tough test.
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