Could Middle East War Rekindle Runaway Inflation?

The US Federal Reserve just cut interest rates last month. The European Central Bank also cut interest rates in recognition of lower inflation. Now, that may be about to change if the violence in the Middle East escalates further.

Brent crude topped $80 a barrel on Monday, fueling reports suggesting Israel may respond to Iran’s missile barrage attack last week sooner rather than later. West Texas Intermediate approached $77 per barrel. By early Tuesday, the benchmarks were slightly down, but the rally was by no means exhausted. If it holds, prices at the pump follow – and so does the price of everything else.

Israel has yet to make a move, but there is no doubt that it will. Tel Aviv cannot afford to let the Iranian attack go unanswered – just as Iran could not let Israeli attacks on its soil go unanswered in the local political context. The only two questions are how severe the move will be and whether it will target Iran’s oil infrastructure.

As analysts ponder the answers and traders follow the news, prices are rising. “While the national average fell slightly over the past week, Iran’s attack on Israel has at least temporarily pushed oil prices to their highest level in months, which could end the declines for now and lead to to an increase in the price of gas. for many Americans,” GasBuddy’s Patrick De Haan said this week, as quoted by the Aspen Times.

Related: Oil prices fall 4% as demand fears outweigh Middle East risk

According to AAA figures, US national averages this week are so far below last week’s average, but that could still change – the week has just started. More importantly, the rally could extend beyond a single week, especially if the conflict between Israel and its neighbors leads to a disruption in Iranian production.

Iran’s oil industry is perhaps the most logical target for Israel. It is a key industry for the country, even under US sanctions, and an attack on it would hurt Iran. However, the pain would spread globally and reach the US, where Israel’s staunchest allies are gearing up for elections. Higher prices at the pump are not something Democrats want to see even before the November vote.

Some analysts point to OPEC’s unused capacity as a reason to keep calm and continue to watch Chinese oil demand. ANZ said in a recent note cited by Reuters that OPEC has up to 7 million barrels of spare production capacity that could be called on in the event of an Iranian supply disruption.

However, this statement assumes that all OPEC members with spare capacity will immediately react to a potential supply disruption by flipping a switch on all their available capacity. The assumption is a little outlandish, given that OPEC has been cutting production for years in an attempt to push prices higher rather than lower. Of course, at some point OPEC would react to a hypothetical Iranian supply disruption, but that moment will not be immediately after the disruption occurs—if at all.

Whatever happens next in the Middle East, the West has just received a reminder of how essential crude oil remains to the health of any economy, even economies marching happily into a future that, at first glance, relies far less than the oil. than economies have done in the recent past. Oil prices are still part of the foundation of inflationary movements – and a big part. It’s good to remind yourself of this from time to time.

As Reuters columnist Jamie McGeever said in a recent column, “There’s almost no corner of the economy that oil doesn’t reach. It heats homes and businesses, powers factories and all means of transport and is a key element in the production of chemicals, plastics, materials and all sorts of goods.” If the oil is gone, everything else grows too.

By Irina Slav for Oilprice.com

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