Global economy: Oil shocks, price spikes and recession risks

Events in the Middle East raise the risk of recessions, point to higher-than-expected inflation in coming months and mean at least delays in expected rate cuts while raising the risk of rate hikes this year in some economies.

For now, however, things remain uncertain, and much will depend on how long hostilities last. Trevor Greetham, Head of Multi Asset, has been arguing for some time that geopolitical risk and tight commodity supply (as we are seeing now) means the world has become more inflation-prone, leading to periods of ‘spikeflation’, as he discusses in his article History’s lessons for a new era of ‘Spikeflation’.

Energy prices not the only way the impact will be felt on developed economies

At the time of writing, the conflict in the Middle East is ongoing, and the effective closure of the Strait of Hormuz shipping route has worsened the impact on oil, gas and other goods prices. Since mid-February, oil prices (Brent) are up around 50%, and European natural gas prices are up approximately 60%.

While much of the focus has been on oil and gas where prices clearly feed through into higher production costs for goods, closure of the Strait will also have already worsened the impact on other commodities and resources (fertiliser costs, sulphur and aluminium, for example). The post-pandemic period already showed the damage broader supply chain pressures can do to consumer inflation.  

Big picture = Lower growth, higher inflation

Rising energy and commodity prices look set to harm economic growth and drive-up inflation at a global level. The IMF’s Georgieva, notes that a sustained 10% rise in oil prices could boost inflation by 0.4pp and lower global growth by 0.1%–0.2%. Extrapolating this to reflect the recent rise in oil prices (at the time of writing), if sustained, global inflation could be boosted 2pp, and GDP hit by 0.5%–1.0%.

Impact will differ by economy

The US as a big oil producer should see less impact on GDP, while the UK and Euro Area, as net oil and gas importers, seem likely to face a bigger hit to GDP. European economies are especially sensitive to natural gas prices due to its role in the energy mix.

• More modest impact on the US economy: As a substantial oil producer, the effect on US GDP may be more modest, but an oil price shock will still be painful for US consumers and businesses and the US will also be impacted by any changes to financial conditions. A 2024 Fed research piece suggested that a 10% higher real oil price could raise headline inflation around 0.15pp over a year and lower GDP by around 0.08% after two years (so at recent energy prices, around a 0.8pp rise in inflation and perhaps a 0.2pp hit to GDP for 2026).
• Potential impact on Euro area: We would watch natural gas prices as much as oil prices. A recent ECB working paper found that a 10% gas price rise raises inflation by 0.6pp after one year. However, in ECB staff analysis from December, a sensitivity analysis where oil prices rose 14% and gas prices rose 20% (so around a third of what we have seen to date) lowered GDP by one-tenth and increased inflation by 0.5pp compared to baseline. That suggests that if energy prices remain where they are, 1.5pp higher inflation and 0.3% lower GDP growth look reasonable starting assumptions.
• Similar for the UK? UK retail electricity prices update quarterly and wholesale gas prices play a key role in the UK’s energy mix and in setting those prices. In their March 2024 report (Box 2.2), the Office for Budget responsibility analysed a more severe Middle East scenario than we are currently experiencing, but that analysis suggests to us that an impact from higher energy prices some 3pp on inflation would be plausible if prices stayed where they were at the time of writing for a year. BoE DSGE modelling from the August 2025 monetary policy report (Box D), suggests a 10% rise in energy prices being associated with a peak increase in CPI inflation of around 0.5% and, after a year, a 0.1% hit to GDP (so around 2.5pp higher inflation and a 0.5% hit to GDP based on energy prices at the time of writing).
• Fiscal policy response: Different economies face different fiscal and political realities when it comes to possible support packages. However, even the UK, which arguably has some of the least fiscal leeway, has already announced a package to help vulnerable heating oil customers and it would not be a surprise, if energy prices stay elevated, to see broader package of support for vulnerable households and for the government to again drop the Autumn increase in fuel duty.
• Monetary policy response:  For now, rate cuts look less likely and rate hikes more likely than they did. The shock could be prolonged and – given recent experience of high inflation and – could more easily see inflation expectations rise. For the BoE (cutting rates gradually but worried about inflation persistence), it makes sense to pause and assess for a while. That doesn’t mean they won’t end up cutting rates again (and UK rate cuts are still pencilled into the forecast), but we may need to wait a while. We still assume that the Fed cuts rates by year end (for now), but that is more likely to be later in the year. With the ECB already at neutral, a rate hike now looks more likely than a rate cut in 2026. However, ‘on hold’ through 2026 remains the central case for now.

Oil and gas prices could remain elevated at recent levels for a number of months, leading to more significant macroeconomic consequences.

Scenarios important – if this all ends soon, do we need to worry at all?

Following on from scenarios for ongoing events in the Middle East outlined by Head of Multi Asset, Trevor Greetham, we outline three economic scenarios:

A short-lived Venezuela-like scenario

President Trump does a Venezuela-like deal with a new and more compliant leadership in Iran, while keeping the regime in place. In such a scenario, the Strait of Hormuz re-opens, and oil prices drop significantly with limited lasting damage.

• GDP: We would expect negligible impacts on GDP growth for the major economies.
• Inflation: A modest short-term rise in inflation may occur, with very modest longer-lasting impacts.
• Central banks: We would expect central banks to ‘look through’ the temporary impact on inflation and do not see central bank policy trajectories being knocked off course. Policymakers nonetheless tread carefully in the near-term with any rate cuts delayed.

Prolonged conflict scenario

In the second scenario, there is more prolonged conflict and/or instability. Oil and gas prices could remain elevated at recent levels for a number of months, leading to more significant macroeconomic consequences.

• GDP: We would expect GDP growth to slow, with the UK, Eurozone and Asia economies most affected along the lines of the numbers cited earlier.
• Inflation: A substantial rise in headline inflation would be likely, with impacts on inflation of ~1pp (varying country to country) plausible.
• Central banks: We’d expect central banks to "look through" the initial rise in inflation; however, policymakers would likely raise rates if evidence of second-round effects emerge.

Prolonged stagflationary scenario – recessions and significant second-round inflation effects

A worst-case scenario could see energy prices move significantly higher on a prolonged basis, with global shortages of oil and gas. Higher inflation rates, second-round effects and recessions follow.

• GDP: A shortage of oil and gas would constrain overall economic activity and weigh on consumer and business confidence. Economies such as the UK, Eurozone, and Asia are likely to experience greater impacts, with the US shielded by its own oil and gas production.
• Inflation: Inflation would rise substantially, in this scenario raising inflation expectations and leading to more significant second round effects (with the high inflation post-pandemic period still fresh in people’s memories).
• Central banks: Central banks raise policy rates in response to elevated inflation levels, aiming to contain second round effects.

For now, we don’t know which scenario is the most likely/appropriate and neither do policymakers. For us that is a recipe for central banks holding fire on any planned rate cuts for a while, adding a bit of downside into global growth forecasts, adjusting inflation forecasts in response to energy prices (leaning somewhere in the middle of these scenarios for now at ~1pp higher inflation than previously) …and to keep those forecasts under review. Worse and better outcomes are possible. For now, risks feel skewed towards worse outcomes as closure of the Strait of Hormuz helps widen the price impacts of this crisis to far more than just oil and gas.

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