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Shockwaves from the Gaza War begin impacting the global economy

Key factor for the global economy is to prevent escalation
IMF.org
IMF releases latest World Economic Outlook report on October 10

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In this era of globalization almost any regional crisis can be expected to trigger defensive strategies on the part of major companies and investors. These basic responses have in fact become so automatic it is impossible to distinguish between reactions produced by machine trading, now enhanced with AI, those of experienced crisis managers looking for short-term profit, or knee-jerk responses by fresh-out-of-university commodity and currency traders.

All invariably make a dash to “safe” investments usually denominated in the US dollar and/or precious metals and most will also attempt to secure medium-term energy deliveries before prices surge.

These kinds of moves should surprise no one after the Hamas-Israel War erupted on October 7.  What merits further investigation here are new signals from the world’s international financial institutions as well as global markets in general about the crisis’ potential impact on an already slowing global economy.

Now, even as the war moved into a second phase October 28 with limited Israeli ground incursions into the Gaza strip itself, the reaction of major economic indicators has not been disproportionate.

IMF closely monitoring conflict’s impact

Speaking at the International Monetary Fund-World Bank annual meetings in Morocco on October 13, IMF Managing Director Kristalina Georgieva said the organization was “very closely monitoring how the situation evolves” and how it would affect oil markets.  Not willing in the war’s first days to be pinned down, she said it was “too early” to assess the economic impact of the conflict, but “this is a new cloud on not the sunniest horizon for the world economy – a new cloud, darkening this horizon.”

The IMF’s World Economic Outlook, which was released earlier last week ahead of the annual meeting in Marrakesh, but drafted before the conflict broke out, already showed weak global growth. The global economy’s recovery from the COVID pandemic has been hit by Russia’s invasion of Ukraine, persistently elevated inflation as well as high-interest rates.  The IMF has kept its growth forecast at 3.0 percent for this year but reduced it to 2.9 percent for 2024, warning that the global economy is “limping along, not sprinting.”

Global oil prices have seesawed, jumping at the start of the conflict before easing and rising again in mid-October on concerns about supply flows.  This was followed by other small adjustments – the usual market reaction to the news of the day.  However, IMF Chief economist Pierre-Olivier Gourinchas noted that IMF research shows that a 10 percent increase in oil prices could reduce global growth by 0.15 percentage points and increase inflation by 0.4 percentage points.

In Marrakesh, US Treasury Secretary Janet Yellen said she was not seeing signs of “major economic ripple effects” at the early stage. “It’s critically important that the conflict not spread,” Yellen said.

Geopolitical uncertainties inject additional costs

With the IMF’s prediction of a gradual downturn in 2024 in mind, it had already become difficult to find optimism regarding the global economy before the Gaza war erupted.  “Over few months, the world economy has entered into troubled times with the war in Ukraine, conflict in Azerbaijan (and an) awful terrorist attack in Israel,” French Finance Minister Bruno Le Maire told foreign media in Marrakesh. “Geopolitical risks are the most significant risks for the world economy now,” Le Maire added.

Even if the world does not tip into recession in the short term because of oil price increases, deferred investment decisions by major companies due to the crisis could accelerate next year’s already expected global slowdown.  What is clear now, however, is that regional companies in the tourism and transport sectors have no choice but to brace for losses.

For the time being, most analysts are focusing on a “confined war” scenario, which was clearly the key strategic intention of US President Joe Biden as he made his Israel visit mid month.  Bloomberg Economics estimated that in such a scenario, oil prices will increase by up to $4 per barrel, while inflation would creep globally up by 0.1 percent, and growth could drop by 0.1 percent.  This seems manageable and is probably the best possible outcome at this point.

A number of other scenarios are being developed, but estimates remain only as good as the assumptions. Bloomberg Economics has also estimated that in an escalation scenario involving Iran, oil prices could soar to $150 a barrel and global growth could drop by a whopping 1.0 percent, falling to a mere 1.7 percent – tipping many countries into a recession that could take about $1 trillion off world output.  High oil prices would also have sharply negative implications on key elections next year, something not just Iranian and Hamas leaders but also Vladimir Putin might appreciate, along with the additional oil revenues.

Israel bracing for a longer conflict

As the war drags on, Israeli authorities have been developing assistance plans to cushion the private sector that is now suffering labor and other shortages due to the country’s massive war mobilization effort. These shortages are especially noticeable in the tech start-up sector.  The mobilization effort has been estimated to cost Israel in the area of $250 million per day and the Israeli shekel has been very gradually depreciating against the US dollar over the month of October.  With some exports disrupted due to transport problems, and most foreign tourism being canceled or at the very least postponed in a period when nearby Europeans would normally be visiting the country for warmer weather, this is understandable.

While Israel has substantial foreign exchange reserves and a manageable debt load, in fact better than many Eurozone countries, an extended war scenario will require at least a small number of new belt-tightening measures.  PM Netanyahu has frequently spoken of a long war scenario in order to prepare public opinion for new measures, both economic and security related.

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