Israel Attacks Nuclear Facilities in Iran: Implications for economy and markets
Last night, Israel attacked nuclear facilities in Iran and killed several military leaders. Although fears of an Israeli strike on Iran—aimed at preventing the development of a nuclear bomb—have been growing for some time, the hope remained that diplomacy would prevail. It is still unclear why Israel has chosen to strike at this specific moment.
What is clear, however, is that this significantly escalates geopolitical tensions. The region is the world’s most important energy exporter and has the potential to become the center of a much larger conflict—both regionally, if Iran’s allies in Lebanon and Yemen retaliate against Israel, and globally, if Iran receives increased support from Russia and China, and Israel from the United States.
In response, oil prices surged this morning, while stock markets declined due to the uncertainty. The spike in oil prices constitutes a negative shock for a global economy that is already weakening. In the short term, this will result in higher inflation, though likely temporary, as the negative impact on growth will be more severe.
Iran will undoubtedly seek retaliation, and Israel has indicated that its offensive is not yet over. Further escalation could push oil prices even higher. However, around $80 per barrel, a price ceiling might emerge, as many OPEC countries could ramp up production at these levels. Many of these countries—such as Saudi Arabia and the Gulf states—support efforts to prevent Iran from acquiring nuclear weapons, as it would dramatically shift the balance of power in the Middle East in Iran's favor. Against this backdrop, they are motivated to prevent oil prices from rising too far, as this could jeopardize U.S. support for Israel.
The ultimate economic and market impact will depend on the extent to which this conflict escalates.
In the best-case scenario, tensions will ease within days or weeks—once Israel believes it has met its objectives and Iran has retaliated. Oil prices could then fall again, better reflecting the weakening global growth outlook. In this scenario, the temporary oil price surge would not have lasted long enough to cause significant economic damage. The narrative of a gradually weakening economy, as outlined in this week’s GFM, would remain intact.
In the worst-case scenario, more countries become involved, Iran retaliates by closing the Strait of Hormuz (a key passageway for OPEC oil exports), and oil prices spike significantly and remain elevated for a longer period. The global economy could then easily be pushed into a recession, with prolonged and intensified inflationary pressures. Central banks would need to be cautious in loosening monetary policy, as doing so could further fuel inflation expectations.
History shows that such conflicts often fade quickly, and we believe this is the most likely outcome again. Israel lacks the capacity to sustain a two-front war for long, and we expect Iran—under pressure from China—not to close the Strait of Hormuz (at least not for an extended period). China, after all, receives a substantial portion of its energy via this route. In other words, stock prices may fall further in the short term, but we expect a relatively swift recovery afterward. Similarly, oil prices may rise temporarily before declining again.
Given that the U.S. is energy self-sufficient and Europe is a major energy importer, these geopolitical tensions put downward pressure on the EUR/USD exchange rate. Should the conflict subside within days or weeks, we expect EUR/USD to resume its upward trend.
However, if the situation does escalate and Iran closes the Strait of Hormuz for a prolonged period, we anticipate a global recession, a bear market in equities, and significantly higher oil prices. Recovery would then hinge on central banks being willing to open the monetary floodgates once more.
