In broad terms, equity markets have now recovered from the losses experienced in early April, when Donald Trump’s tariff announcements knocked confidence in international trade. The positive performances that followed successful tariff negotiations may give the impression of a settled global order, but with a volatile conflict in Iran among a range of challenges, that is clearly not the case. There is a huge amount of news to digest at present, but with longer-term economic trends still broadly positive, investors are proving patient.
Israel-Iran and Market Implications
Prior to the launch of Israel’s attack on military and nuclear targets in Iran on 13th June, the price of a barrel of brent oil was $69. Since that time the price has risen, reaching a high point of $79 on 23rd June. A price jump is no surprise given fears of the disruption this conflict could cause in an important oil-exporting region. Yet, at just a 14% increase, this does not represent a panic move by investors. The most expensive oil has been in recent years was above $120 reached in the months following Russia’s invasion of Ukraine in early 2022. Even over just the past 12 months there have been multiple times when the price of a barrel has exceeded $80. This suggests a judgement that this conflict is unlikely to materially impact the supply of oil upon which the global economy depends.
The situation is evolving quickly. Over the weekend the US joined the war with its targeted strikes on Iranian nuclear sites. Iran then responded with pre-notified strikes against US assets in Qatar, all of which were intercepted. The US has accepted this response as proportional and has since mediated a ceasefire between Israel and Iran. At the time of writing, there is uncertainty over whether this truce will hold, and consequently oil prices are fluctuating on the morning of 24th June.
While this is still a developing story, the muted market response so far is largely due to the nature of the conflict. Crucially, oil infrastructure has not been targeted, allowing Iran’s oil exports, particularly to China, to continue largely uninterrupted. Meanwhile, Iran has taken no action to disrupt the shipping of oil from the Gulf states as they pass through the vulnerable Strait of Hormuz on their way to global buyers.
It is possible this could change in the weeks ahead, and if it does, the consequences could be severe. Any threat to oil exports or shipping lanes would likely drive prices significantly higher, stoking inflation and potentially slowing global economic growth.
A dampening effect, however, is that unlike in 2022, when the global economy was rapidly expanding following the release of covid lockdowns and prices shot up as Russian oil and gas were blacklisted, global economic activity is now waning. The International Energy Agency has forecast that global oil supply will outpace demand this year, thanks to increased OPEC production and weaker consumption in China and the US. This could help temper any price spikes created by war in the Middle East.
Inflation and Interest Rates: A Delicate Balancing Act
Last week saw inflation data and central bank decisions from both the US and UK, underscoring the ongoing challenges policymakers face when trying to balance their economies.
In both countries, interest rates were maintained at their current levels (a range of 4.25%-4.5% in the US and a fixed 4.25% in the UK), yet markets predict that there will be two cuts apiece before the end of this year, with August seeming likely for the next Bank of England cut and September for the US Federal Reserve. The challenges faced by both central banks are similar. Inflation remains above target, yet forecasts for economic growth are deteriorating, with signs that labour markets on both sides of the Atlantic are cooling.
Donald Trump’s erratic governance and his tariffs are denting confidence globally, but this is especially impacting the American economy, with Fed Chair Jay Powell nervous that the one-off price rises from tariffs could set off a chain reaction leading to further sustained inflation. In 2021 and 2022, Powell and his Fed colleagues were wrong to label the emerging signs of inflation as mere transitory factors, which meant they were too slow to raise interest rates and hence exacerbated the inflation pain felt in late 2022 and 2023. Powell appears, therefore, very hesitant to repeat this mistake and does not want to prematurely cut interest rates, even if he is under increasing pressure from Donald Trump to do so. Such interference is evident, as Trump has suggested interest rates should be a full 2% lower than they currently are and he has proposed appointing a ‘shadow chair’ to undermine Powell’s position.
In the UK, economic growth for the first 3 months of the year was strong, but in April, this significantly worsened with a -0.3% GDP reading for the month. Inflation, at 3.4% and forecast to stay at a similar level for the rest of the year is well above the 2% target. While unstable international factors play a role in this, domestic concerns are also present, with last Autumn’s budget playing a role. The higher cost of employment through the increase to national insurance contributions and minimum wages is adding costs to businesses and reducing confidence.
Overall, inflation remains a thorn in the side of central banks, and rate cuts are only likely to be gradual, if they happen at all. These challenges have already been in place over recent months, but with conflict in Iran, another layer of complexity has been added to the decision-making of the Bank of England and the Federal Reserve.
U.K. Spending Review: Long-Term Promise, Short-Term Pain
Just as the implications from Rachel Reeves’ decisions from last autumn are working their way through the economy, attention must turn to her longer-term plans and those of the Prime Minister, with the government’s spending review outlined earlier this month and a new Industrial Strategy announced by Kier Starmer in yesterday’s press. Ms Reeves’ plans include £113 billion in capital spending on railways, nuclear power, and housing, and a further £725 billion over the next decade for infrastructure. Meanwhile, Mr Starmer’s announcements aimed to lower energy cost for businesses, along with a list of other priorities the government believes will unlock higher productivity.
These long-term investments and plans are a welcome step toward addressing the country’s chronic productivity issues. However, the short-term picture is more challenging.
With the economy slowing and higher than expected borrowing costs, the Chancellor’s much-referenced £10 billion fiscal headroom is at high risk of disappearing by the time of this year’s autumn budget. What’s more, with the government nervous of a strongly performing Reform party, political pressures are mounting. Reeves has already reversed a £1.25 billion cut to the winter fuel allowance and faces resistance over her planned welfare cuts from both inside her own party and outside. This suggests more tax rises are on the horizon to fund greater spending. While this would lessen the political pressure, it will not ease economic concerns. With the tax burden already high by historic standards and the economy stuttering, businesses will be nervous as we await the budget over the coming months.