War Raises Oil Price, Inflation, and Interest Rates!
The start of this week saw the Brent Crude market move a huge $35 per barrel between its intra-day peak to close. Trader uncertainties were heightened and then calmed by the potential release of strategic oil reserves in the West and President Trump saying, ‘the war will be over very soon.’
It is worth noting that at its peak on Monday this week, the oil price was up 80% from the start of the war but today as we go to print the price is now only 32% higher.
The effective closure of the Strait of Hormuz is fuelling fears of an oil shortage and painfully reminding all of us that our economies are still far from decarbonised. Whether it is heating, travel, digital infrastructure, plastics, fertilisers, metals, almost everything relies on the production and combination of oil and gas.
The Strait of Hormuz route oversees the movement of 30% of world oil and 20% of traded oil. Due to safety concerns and the prohibitively high insurance from Lloyds, the passage is paralysed with Tankers all anchored down.
Refineries and storage facilities have quickly reached full capacity which means that countries like Iraq, Kuwait, UAE, and other Gulf states have had to restrict the production of oil as there is no where for it to go! A few of these facilities have war damage whilst others have undergone planned and substantial production cuts. Returning to normal activity will not be easy or quick like switching a light on.
On Sunday last week, Iran announced the appointment of Mojtaba Khamenei as Supreme Leader (the second son of the assassinated leader), a way of signalling the continuity of the hardline regime.
With Iran widening targets to infrastructure in the Gulf such as a desalination plant in Bahrain, it is worrying whether the patience of the Gulf states can hold. At present, they are only defending their countries and not retaliating. Let us all hope that the fear of escalation to the conflict keeps Gulf state actions to merely one of protection.
When the conflict started 11 days ago, there was widespread investor optimism that it would be a short and abrupt war. Recent events and Iranian announcements to date have suggested it could drag on for much longer and that is why the oil price has surged to higher levels and upset financial markets.
It has already had a marked impact on higher inflation expectations, which in turn has caused UK mortgage rates to move up by at least a quarter of one per cent for fixed rate offers and the potential is for these to move even higher. In the US, mortgage rates have edged comfortably above 6% again, curtailing consumer confidence and growth estimates for this year.
With petrol being an important cost for US consumers, it could restrain consumer spending this year bringing reduced growth but higher inflation. The term ‘stagflation’ springs quickly to mind, which is hardly an inspiring background for investors!
If the war in the Middle East and its consequences were not enough, the market had to digest a poor US employment report for February. Expectations of a 55,000-job creation was wildly wrong with the actual number a negative 92,000 jobs. The US February freezing weather and a widespread strike could account for weakness but even so, the Federal Reserve now appear to be facing both rising unemployment and inflation.
On Wednesday this week, one question may be answered as the US inflation figure is released for February. If the number is stronger than expected, investors fear of a renewed inflationary cycle will be reinforced.
Friday sees the releases of the Federal Reserve’s preferred inflation measure and the second estimate of the fourth quarter 2025 growth. Each of these can move market sentiment sharply. Finally, a bit further out to next week, the Federal Reserve meet, but barring a major surprise is expected to keep interest rates unchanged.
(Cover Image Source: UX Gun)