Renewed hostilities in the Gulf have renewed talk of stagflation, dimming hopes that a recent interim accord between the United States and Iran had removed a major inflationary threat. In the wake of attacks that widened disruptions to shipping routes, Brent crude climbed back to $100 a barrel, European natural gas futures posted their largest monthly gains since March, and government borrowing costs across major markets rose as investors weighed the prospect of persistent price pressures amid slowing growth.
Energy markets have been the immediate transmission mechanism for the shock. Brent, having slid to around $70 in early July on optimism about a ceasefire, surged after Yemen’s Houthi militants said they struck two Saudi oil tankers in the Red Sea. Oil is up nearly 40% in July and is set for its biggest monthly rise since March. European gas benchmarks have also moved higher, trading at levels last seen in March.
Those price moves have rippled into financial markets. Government bond yields from the United States to Japan and Germany rose sharply this week as higher energy costs pushed inflation expectations higher. Measures of long-term inflation expectations have so far moved only modestly, but analysts warn that rapid commodity price swings can be slow to feed fully into market pricing.
"Stagflation risk has been very much there for each economy since March, in different ways," said Alessia Berardi, head of global macroeconomics at Amundi Investment Institute. She added that the latest broadening of conflict "increases the risk of stagflation for sure."
Energy and commodities
Energy remains the dominant near-term driver of inflation expectations. Brent's rebound to $100 followed the Houthi attacks on two Saudi oil tankers in the Red Sea, extending supply disruption concerns beyond the Strait of Hormuz. Analysts note that roughly one third of global fertiliser shipments transit the Strait of Hormuz, according to Kpler, meaning that elevated energy and shipping risks could keep food and agricultural input prices elevated for longer.
Separately, this year's El Niño weather pattern is also exerting upward pressure on commodity prices, contributing to the overall cost backdrop.
Inflation expectations and central bank reaction
U.S. consumer price inflation for June came in lower than expected last week, offering only temporary relief. As energy prices climbed again, markets pushed out expectations of monetary policy paths and priced additional tightening from major central banks.
Traders now expect roughly two additional quarter-point rate hikes from the European Central Bank by year-end, on top of its June move. The ECB left policy rates unchanged on Thursday but signalled that further tightening may be required. In the United States, expectations for additional Fed moves had eased after the June inflation print but re-emerged as the commodity shock unfolded; markets are pricing around two hikes by January. U.S. inflation has been above the Fed's 2% target for five years.
Higher interest rates, however, create a policy dilemma. For energy importers such as the euro area, raising rates to contain inflation also risks slowing growth - an unwelcome outcome when an energy shock is already weighing on economic activity. "The European Central Bank has looked more willing to raise rates into oil-driven inflation than the Federal Reserve," said Andrew Sheets, global head of fixed income research at Morgan Stanley. He warned that Europe may face a double hit from both higher energy costs and tighter financial conditions.
Market signals and economic strains
The currency market has already reacted: as oil reached $100 on Thursday, the euro slid to three-week lows below $1.14. In Asia, countries that import most of their oil from Gulf suppliers - particularly in South and Southeast Asia - face acute pressure, with some struggling to afford higher energy bills.
Japan, while able to pay for higher imports, is recording a rise in import costs as the yen remains weak at multi-decade lows versus the dollar. That weakness has pushed the value of Japan's imports to a record high in June, contributing to domestic inflationary trends.
The United States, though a net energy exporter and less exposed to direct import cost pressure, is not insulated. Average fuel prices at the pump have climbed back above the psychological $4 per gallon threshold during the peak summer driving period. U.S. airlines have also taken a hit: combined fuel expenses at four major carriers were nearly $8 billion higher than a year earlier. Higher sovereign yields have translated into higher mortgage financing costs - the most common U.S. home loan rate climbed last week to its highest level since last August.
Trade tensions and broader uncertainty
Trade policy developments have compounded the economic uncertainty. The U.S. on Friday imposed new tariffs of 10% and 12.5% on goods from 60 trading partners, including the European Union and China, a move that is likely to put upward pressure on consumer prices and add to business planning uncertainty.
These intersecting shocks - a renewed energy price surge, higher shipping risk, weather-driven commodity pressure, and new trade barriers - have brought stagflation risks back into focus. The World Bank's chief economist told Reuters this week that the war could push global growth down to as low as 1.3%, from 2.9% last year, suggesting that slowing growth could accompany higher inflation.
What to watch next
- Movements in energy prices and freight disruptions, particularly related to shipping in the Red Sea and the Strait of Hormuz.
- Market pricing of central bank policy moves - whether the ECB and Fed will tighten further in response to higher energy-driven inflation.
- The trajectory of trade measures and their pass-through to consumer prices and corporate costs.
For investors and policymakers, the combination of higher energy prices and tighter financial conditions presents an uncomfortable trade-off. Policymakers aiming to restrain inflation must weigh the cost of further slowing economic activity, while households and companies confront higher energy and borrowing bills amid an uncertain growth outlook.