The military conflict in Iran and the Middle East is curtailing the global flow of oil and natural gas. This adds notable pressure to energy prices and the near-term inflation outlook, while also raising questions about countries’ reliance on energy imports and their economic resilience.
The longer the Iran conflict drags on, especially if we see more pronounced damage to energy infrastructure alongside suspended production and constrained shipments through the Strait of Hormuz, the global economy could be at risk of a more prolonged energy supply shock.
So far, the market reaction appears focused on upside inflation risks and the implications for monetary policy. The shortest-dated interest rates across developed market economies have shifted to pricing higher chances of central bank rate hikes, along with generally higher real yields and flatter interest rate curves – a mix that has tightened financial conditions.
Conventionally, central banks tend to look through supply shocks. After the post-pandemic period of elevated inflation, a large supply shock could lead to more persistent inflationary pressures as inflation expectations and wages also adjust higher. However, economies are in much different positions now versus the immediate post-pandemic period when, for example, Russia’s invasion of Ukraine in 2022 sent energy prices soaring.
Along with potentially pressuring inflation higher, the energy shock also creates downside risks to growth, especially in countries that are net importers of energy. The U.S. economy, even though it has become a net exporter of energy, also looks more vulnerable given its already weak labor market.
Central banks weighing downside risks to growth and employment against the risks of a (likely temporary) inflation spike may conclude that they do not necessarily need to deliver the hawkish reactions that markets have priced.
Economic implications of a global energy supply shock
In broad terms, the Middle East conflict and ensuing increase in energy prices are forcing the global economy to confront a stagflationary supply shock. We see four main channels of transmission: 1) higher energy and food prices, which reduce real incomes, 2) disrupted supply chains and trade flows, 3) tighter financial conditions, and 4) lower business and consumer confidence due to heightened uncertainty.
While the energy price impact is likely to push up headline inflation universally across countries, the GDP impact will vary based on a country’s net energy export status, and global growth will likely shift lower on net. Within developed markets, Europe, the U.K., and Japan are energy importers and face larger downside growth risks, while Canada and Australia’s net energy export status should help buffer the real income blow.
High oil prices and potential energy shortages will likely weigh on global manufacturing as well, with net energy importer countries across Asia already seeing manufacturing stoppages. Petrochemicals refined from Middle East oil are a key input across Asian manufacturing (including in China), and with stocks limited, there is a risk of broader knock-on effects to supply chains.
Potential impact on the U.S.
In the U.S., two decades of net increases in shale production have turned the country from a net importer of energy to a slight exporter. This means the U.S. may not face as severe a hit to GDP from an energy supply shock, but given the magnitude of the price increase thus far, the net impact would still likely be negative as the real income drag outweighs any potential increase in production (at least in the near term).
The dramatic increase in global oil prices has coincided with similar increases across refined products, including wholesale gasoline, heating oil, and natural gas. Jet fuel prices have skyrocketed. U.S. retail gasoline prices are increasing due to both higher oil costs and higher refining margins.
According to the American Automobile Association, the national average retail price of a gallon of gas as of this writing (on 10 March) has increased roughly 20% since mid-February and could increase further in the coming days. A positive 20% energy price shock could raise the year-over-year rate of headline U.S. inflation (as measured by the Consumer Price Index or CPI) by roughly 1 percentage point, according to our estimates.
Here’s the math behind that estimate: Energy commodities and services make up roughly 5% of the consumer expenditure basket (of which 3% is gasoline), so a hypothetical sustained 20% increase in energy prices would contribute around 0.8 percentage points (ppts) to the year-over-year rate of headline CPI inflation. Higher energy prices also affect the prices of goods and services that use energy. We estimate that the pass-through of 20% higher energy prices could raise the prices of non-energy goods and services 0.2%–0.4%, contributing another 0.2 ppts to the headline rate.
The flip side of roughly 1 ppt higher inflation is a reduction in real incomes, which would weigh on real consumption. Assuming nominal wages, at least in the short run, don’t increase, higher prices would reduce households’ real purchasing power. Hypothetically, if consumers spend down savings to offset half of the real income hit, real consumption growth would still fall by 0.5 ppts. That’s a meaningful headwind to growth that would be difficult to fully offset via a boost in U.S. energy production, which would only increase over time, assuming prices are sustained.
Initial conditions matter
Where the U.S. economy stood before this shock is also important. Unlike in the wake of the pandemic, when the private sector received over $5 trillion in aggregate transfers from the U.S. government and had pent-up demand from the shutdown, the U.S. economy enters the current energy shock with weaker fundamentals. Over the past year, despite the resilience in real GDP growth, labor market income growth decelerated, largely due to the impact of tariffs, immigration policies, and government job cuts. After growing over 2% in 2024, aggregate incomes grew roughly 1% in 2025 (according to the Census Bureau), with higher GDP and real consumption growth in large part supported by households dipping into savings. According to the National Income and Product Accounts (NIPA), the national savings rate declined from a peak of 5.5% in April 2025 to 3.6% as of December – still above the post-pandemic historical low of 2.3%, but closer to a point where households may feel forced to reduce consumption.
On the positive side, many U.S. households are receiving higher tax refunds (or have fewer taxes still owed) due to the One Big Beautiful Bill Act. The latest IRS data suggest the average refund per household is up 10% versus last year, and many households haven’t filed yet. We estimate that household tax cuts could be worth 1%–1.5% of real GDP, with the average refund likely to be $1,000 more than what was received last year. However, higher gasoline prices and additional annual energy costs per household will likely offset the gains from tax policy.
Implications for monetary policy
Central banks are in a tough position. In developed markets outside the U.S., markets are now pricing policy rate hikes across several regions in light of energy-related inflation pressures. Conventional wisdom says central banks should look through a supply shock. In practice, it might be more difficult for inflation-targeting central banks to cut into accelerating inflation; however, hiking rates into decelerating growth would also be difficult. The knee-jerk market reaction toward tighter financial conditions and more hawkish monetary policy estimates is already doing much of the hawkish work for them. And if inflation does prove temporary while downside growth risks materialize, central banks may need to ease more aggressively.
Takeaways for investors
Amid geopolitical and broader uncertainty, the stability of fixed income and the flexibility of active management are increasingly important. We look to emphasize quality, diversification, and liquidity.
Learn more in our recent video, “Iran, Oil, and Rates: What We’re Watching.” And later this month, look for our new Cyclical Outlook, which will offer in-depth views on the global economy, markets, and investing.
