Global geopolitical tensions often play a crucial role in people’s perceptions of economic growth. Research shows that concern about such issues can cause people and businesses to become more cautious about spending and investing, which can ultimately lead to an economic recession.
The recent escalation of the Israeli-Palestinian conflict is no different. Investors around the world are worried about the impact of this war – especially given the already bleak outlook for global economic growth.
Hamas’ attack on southern Israel on October 7 is the latest chapter in a vicious cycle of violence that has persisted in this region for decades and, unfortunately, appears to have no end in sight. While the reasons for these events are complex, the potential immediate and long-term economic impacts of the conflict are easier to understand.
Because if the war between Russia and Ukraine has taught us anything, it is that we should be aware of the complicated interdependencies that shape the global economic and geopolitical landscape.
How conflicts can affect the economy
Internal and interstate conflicts often have a significant impact on stock market indices, exchange rates and commodity prices – sometimes even leading to higher prices in advance of hostilities. However, the longer-term economic impact is typically more difficult to estimate. The lasting impact of even seemingly dramatic events on investor behavior can be difficult to predict.
Conflicts in the Middle East tend to increase oil prices – think of the OPEC oil embargo of 1973-1974, the Iranian Revolution of 1978-1979, the Iran-Iraq War that began in 1980, and the first Gulf War in 1990-91. With the region accounting for nearly a third of the world’s oil supply, any instability could lead to market uncertainty based on concerns about disruptions to global oil supplies.
This uncertainty is reflected in the risk premium on the oil markets. This is the price paid for oil traded in advance in the futures markets compared to the real-time price of oil. It reflects the profits that speculators expect from buying and selling oil in times of conflict, as well as the hedging needs of companies that produce and consume oil and their concerns about supply and demand.
Therefore, the impact of the recent Israel-Hamas conflict on global financial markets will depend on the involvement of other major regional powers. If the conflict between Israel and Hamas persists, the impact will likely be limited and only affect countries that trade directly with Israel or Palestine.
However, if the conflict spreads to major oil-producing countries in the region such as Iran, it could have a serious impact on the global economy as energy costs for businesses and households could skyrocket if supplies are disrupted.
Higher energy prices would hamper central banks’ efforts to contain inflationary pressures in most developed and emerging markets. If this leads to “longer-term higher” monetary policy that keeps interest rates high, it would drive up borrowing and refinancing costs for governments, businesses and people.
History can provide some insight into how the impact of these different scenarios could affect the global economy. For example, the 50-day war between Israel and Hamas in 2014, in which 2,200 people, mostly civilians, were killed, had no significant impact on the global economy or financial markets.
But when Israel and Hezbollah clashed in Lebanon in 2006, global oil prices rose on fears of a wider conflict in the Middle East.
What awaits you this time
Unfortunately, there is another factor to consider at the moment. The escalation of the Israeli-Palestinian conflict has been accompanied by the realignment of various global alliances. This slow progression of “deglobalization” can be observed in changes to trade policy in recent years.
Countries such as the United States and the United Kingdom are relocating their economic activity, including sourcing or manufacturing products from other countries, due to fears of dependence on suppliers in potentially hostile regions as well as the impact of imports from low-cost countries on struggling local labor markets
These shifts can also currently be seen in the reactions to the Hamas attack on Israel. A two-state solution to the Israel/Palestine conflict was originally outlined by the United Nations in 1947 and reaffirmed in 1974 with near-unanimous support around the world.
However, there were some nuances in the international response to the attack. While most Western countries quickly expressed support for Israel’s right to self-defense, while countries such as China and Russia called for a ceasefire without taking a stance on Hamas.
This suggests that the Israel-Palestine issue may be related to the broader trend toward new geopolitical divisions that were already emerging before the Hamas attack.
A prolonged conflict between Israel and Palestine, particularly involving major regional powers, could further accelerate this global realignment and have adverse consequences for global economic growth.
Under these circumstances, investors are already bracing for increased financial volatility across everything from stocks and government bonds to commodity markets. So-called safe havens like gold are typically used as protection against overwhelming economic uncertainty. Gold prices have skyrocketed following the recent escalation in the Israeli-Palestinian conflict.
Financial markets will continue to monitor the conflict between Israel and Hamas for signs of escalation. Anything that pushes oil prices higher will reignite fears of higher inflation.
Unfortunately, this comes at a time when many countries have seen a slowdown in inflation after two years of persistently high consumer prices.
Daniele Bianchi is Associate Professor of Finance at Queen Mary University of London.
This article was first published by The Conversation.
Image: Shutterstock.com
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