Global oil prices surged more than 17% to over US$85 a barrel in the week following the United States and Israel’s missile strikes on Iran, triggering volatility in financial markets and raising concerns about a protracted conflict. The attacks, which began last week, have prompted fears of a wider regional war and, critically, the potential closure of the Strait of Hormuz – a vital waterway for global energy supplies, handling approximately a fifth of the world’s oil and gas.
The Australian sharemarket experienced a 3.8% loss for the week, whereas Asian markets, particularly those heavily reliant on energy imports, were significantly impacted. South Korea’s stock market suffered its worst single-session decline in history, plummeting 13%. Despite the international turmoil, the S&P 500 index in the United States saw a more modest decline of less than 1% leading into Friday’s final session.
The Trump administration’s response has been characterized by a demand for “unconditional surrender” from Iran, according to statements made by the President and reported by CNN and the New York Times. This uncompromising stance has fueled uncertainty about the path forward and the potential for de-escalation.
Economists are divided on the extent to which markets have fully priced in the risks. Shane Oliver, chief economist at AMP, expressed concern that markets were “a little bit complacent,” noting the relatively mild response compared to previous geopolitical shocks, particularly those stemming from US tariff announcements. “Markets are assuming there will be some sort of backdown and this won’t be a long, drawn-out war,” Oliver said.
The lack of clarity surrounding the Trump administration’s objectives complicates the situation. Investors are currently pricing in a scenario of a sharp, but relatively short conflict lasting two to three weeks, but are unprepared for a prolonged engagement. The Australian dollar’s resilience, remaining above 70 US cents, reflects an underlying assumption that oil will continue to flow through the Strait of Hormuz, limiting the duration of any major disruption.
Ray Attrill, head of foreign exchange strategy at National Australia Bank, explained that Australia’s position as a major energy exporter, particularly of LNG and coal, contributes to the Australian dollar’s stability. Derivatives markets suggest a return to oil prices in the US$60s or US$70s within a month, but a sustained escalation could trigger a significant decline in the Australian dollar.
The potential for stagflation – a combination of rising inflation and slowing economic growth – is a key concern. Higher oil prices push up fuel costs, contributing to inflationary pressures while simultaneously dampening economic activity. This presents a challenge for central bankers, forcing them to weigh the risks of raising interest rates to control inflation against the need to support economic growth.
Jim Chalmers, Australia’s Treasurer, has warned of “substantial” economic consequences resulting from the conflict. NAB economists now estimate that Australian inflation is likely to peak at 4.75% in the year to June, a half-percentage point increase from pre-war predictions. A sustained rise in Brent crude prices to US$100 a barrel could push inflation above 5%, reaching its highest level since late 2023.
Reserve Bank Governor Michele Bullock acknowledged the risk that rising petrol prices could reinforce expectations of persistent inflation, making it more difficult to bring price pressures under control. While the RBA typically looks past temporary price shocks, Bullock indicated that this situation may require a different approach, given already elevated inflation levels.
Brett Solomon, a senior portfolio manager at QIC, noted that investors have become accustomed to short-lived geopolitical headlines in recent years. However, he cautioned that the current situation could be different, potentially lasting longer and having a more significant impact. Solomon indicated he was maintaining a view that the RBA would increase interest rates one more time in May, but stressed the need to monitor oil prices closely.
Kerry Craig, a global market strategist at JP Morgan, stated that the “base case for most hasn’t changed: that this won’t be something that drags on for months and the outlook for the global economy is fairly decent.” He added that a shift towards recessionary expectations would be contingent on a prolonged conflict.
The Atlantic reported that the goals of the United States and Israel are already diverging, adding another layer of complexity to the situation. As of Friday, the Trump administration had not announced any decision regarding the use of America’s strategic oil reserve to alleviate price pressures, and no further diplomatic initiatives were publicly disclosed.
