The outbreak of war in the Middle East resulting from US and Israeli air strikes on Iranian targets, and subsequent counter attacks, raises the risk of a broader regional conflict. The central economic concern is not Iran’s direct output, but the potential disruption to energy flows through the Strait of Hormuz, a key maritime route that carries roughly one-fifth of global oil shipments.

How are markets reacting?

Oil prices had already risen in anticipation of disruption, with Brent crude climbing sharply over the past month, and spiking again on Monday.

More broadly, market moves have so far been contained. Oil prices have risen but remain below levels associated with a severe supply shock. Equities have seen limited, sector-specific volatility, mainly in energy, while bond markets have stayed broadly stable. Gold prices have risen sharply as investors seek safe havens.

The economic impact will depend on the scale and persistence of any further oil price increase. A $10 per barrel rise is unlikely to materially shift inflation or growth expectations. However, a sustained move towards or above $100 per barrel would pose a more significant risk, potentially adding around 0.6–0.7 percentage points to global inflation and complicating central bank rate-cut plans, as seen following Russia’s invasion of Ukraine in 2022.

Historically, oil shocks have also supported the US dollar and weighed on risk assets if markets begin to reassess the outlook for monetary easing.

Two broad scenarios are emerging.

1. In a contained scenario, shipping through the Strait of Hormuz continues and other producers offset lost Iranian supply. In this case, oil prices may remain elevated but manageable, limiting the impact on global growth and inflation.

2. In a more severe scenario, a prolonged disruption to Gulf energy flows could drive oil above $100 per barrel. That would likely reignite inflation, delay interest rate cuts and weigh on consumer confidence and business investment. As seen in 2022, energy-driven inflation can materially slow growth, and raise interest rates.

At present, markets appear to be pricing something closer to the contained outcome, though risks remain elevated and market volatility is likely to persist.

From an investment perspective, the impact has been modest thus far. Diversified portfolios across asset classes and regions have cushioned volatility, with broader equity and bond markets remaining orderly despite higher energy prices. Diversifying alternatives, such as gold and real assets have provided positive protection.

While geopolitical events can create short-term uncertainty, long-term diversified strategies are built to navigate such periods, and they can create opportunities for investors.