Global economy risks slump on prolonged Iran conflict: OECD

[PARIS] The fate of the global economy hinges on the conflict in the Middle East that has already stifled growth and could yet trigger recessions and significantly stronger inflation, the Organisation for Economic Co-operation and Development (OECD) said on Wednesday (Jun 3).

Price pressures and weakened demand are set to be felt for some time, and may even worsen beyond a potential reopening of the Strait of Hormuz, the Paris-based organisation said in its latest economic outlook.

Even in a scenario of time-limited disruption, the OECD revised up its inflation estimates for 2027 and only slightly tweaked already feeble growth projections it announced in March.

It also presented a bleaker scenario of prolonged confrontation and economic fallout that would trigger the deepest global slowdown for 40 years, outside of the Covid-19 pandemic and the global financial crisis. The world’s inflation would be 0.4 percentage point higher this year and 1.3 points in 2027.

“The conflict in the Middle East has become the dominant force shaping the global economic outlook,” chief economist Stefano Scarpetta said. “The global economy is now again under pressure.”

Weighing on policy

The latest assessment from the club of advanced economies is a stark warning of what is at stake for other countries the world over if the US and Iran cannot find a path to de-escalation.

Predicting the extent to which that is possible is hazardous, as optimism over a deal on opening Hormuz is repeatedly punctuated by renewed threats of attacks and diplomatic setbacks.

Should disruptions persist into 2027, global growth would slip to 1.8 per cent, tipping some economies into or close to recession, driving up unemployment, weakening investment – including in artificial intelligence – and increasing the risk of repricing on financial markets, the OECD said.

The severity of the fallout and the potential for exacerbation will make policy decisions particularly difficult.

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Fiscal expansions will likely shoulder most of the burden, according to the OECD, but governments have little space to intervene due to elevated public debt.

It also warned that the broad support many states have already provided has undesirable effects of encouraging energy consumption in a supply crunch.

Meanwhile, central banks face challenges weighing the need for tighter policy to rein in inflation while avoiding unnecessary economic harm. In the OECD’s milder scenario, it expects some interest-rate increases followed by cuts in 2027 as price pressures retreat.

But the picture becomes more complex if the disruption is prolonged and inflation reaches the more acute projections.

The OECD expects that policy rates would then likely rise by 50 to 75 basis points in most countries, only to be reduced again in 2027 as the drag on growth intensifies.

If there is severe tightening of market conditions, the organisation said that central banks may have to reconsider further reductions in holdings of sovereign bonds acquired in past crises and even reboot quantitative easing or – in the case of the European Central Bank – long-term refinancing operations.

“Central banks can look through the supply-driven rise in prices as long as inflation expectations remain well anchored and second-round effects are contained,” Scarpetta said.

“However, a policy response may become necessary if price pressures broaden, or if growth weakens significantly.” BLOOMBERG