With the war in Iran, growth expectations have weakened around the world, and concerns about accelerating inflation have begun to resurface. In the short term, the situation nevertheless remains positive, although somewhat divided between Europe and the USA.
The war in Iran has remained the focus of the markets, as reports of a possible agreement between the United States and Iran have intensified over the weekend. It has been announced publicly that an agreement may be close, prompting a positive reaction from the markets as well. On the other hand, there is still a risk that the situation will escalate again.
Traffic through the Strait of Hormuz has been at a standstill practically since the beginning of the war. Before the war, around a hundred vessels sailed through the strait daily, but traffic has now virtually ground to a halt, apart from a handful of individual ships.
A crucial share of the energy, fertilisers and certain other raw materials vital to the global economy passes through the strait. As a result, energy shipments have been in short supply, and the situation has been challenging in, for example, many Asian countries.
When the war began, markets speculated that oil and gas supplies could run out within a few weeks in certain regions dependent on Middle Eastern energy. This has not, however, been the case, although many countries have curbed their energy use and prices have risen significantly, which has also had an impact on economic growth. Over the past three months, many countries have resorted to their energy reserves, which are starting to run low. For example in Europe, the refilling of critical gas storage facilities should already be started in preparation for next winter’s heating season. If the crisis does not ease in the near future, this will create challenges.
If the war were to end soon, no permanent damage to the conditions for economic growth is expected. If the situation is not resolved, however, we will most likely see negative effects, particularly through the impact on inflation.
Economic growth expectations have dwindled across the world as a consequence of the war. GDP projections, which reflect full-year growth forecasts, have fallen sharply in recent months in the euro zone, and a notable decline has also been seen in the USA. Weaker-than-expected growth figures reported for the first quarter are also weighing on the full-year numbers.
In the shorter term, the situation is, by contrast, more positive – although divided. Economic surprise indices, which measure official economic results against expectations, have been somewhat weak, particularly in Europe and China. By contrast, US economic data has beaten expectations.
This division shows that the war in Iran is having the strongest impact on Europe and China. The price and availability of energy have a much stronger impact on Europe than the US. A major underlying factor is Europe’s vast, energy-intensive industrial sector, whereas the US is a more service-oriented market whose growth-driving sectors and companies are significantly less dependent on oil.
Meanwhile, the Fed’s current-quarter GDP forecast points to a strong second quarter and GDP growth of over 4 per cent in the US. The Fed’s forecast has been a good indicator of GDP development in recent years, and on that basis the economy could be expected to pick up again after the first quarter. The foundations for positive market performance in the United States remain reasonably strong, but the situation could still change if no resolution to the crisis is found.
Market concerns related to the war in Iran are strongly tied to inflation, which has picked up in many parts of the world. If inflation accelerates further, it could derail positive economic development, as rising prices would weaken demand and thereby slow economic growth. Another – perhaps the most important – factor could be that high inflation often also means higher interest rates, which would inevitably lead to slower growth at some point.
At present, markets are closely monitoring central banks’ responses to the situation. The markets are expecting the European Central Bank (ECB) to announce a quarter-point interest rate hike at its June meeting, followed by one or two additional hikes later in the year. At the beginning of the year, no changes by the ECB were priced in, so the shift from the start of the year is significant. However, the ECB’s decision is highly dependent on how the crisis develops in the coming days.
The US Fed is currently not expected to change the key interest rate at its June meeting. The meeting will nevertheless be of interest to markets, as it will be Kevin Warsh’s first as Fed chair. There are many questions and expectations regarding his future policy direction.
In the USA, expectations have also shifted significantly. At the start of the year, markets were still pricing in a couple of interest rate cuts for the current year, whereas present pricing reflects a quarter-point hike for December.
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