The Decisive | Season 6 | Ep.14 - Frequently Asked Questions: Oil Shocks, Economic Resilience and Risks to Growth

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Kristen Hallam:

Welcome to The Decisive podcast. I’m your host, Kristen Hallam. Today’s episode was originally recorded on May 12 and is based on frequently asked questions our economics team receives from clients. I’m joined by Ken Wattret, S&P Global Market Intelligence’s vice president of global economics, for a wide-ranging conversation on what the recent oil shock and conflict in the Middle East could mean for the global economy. In case you’re thinking this is less relevant in July than it was when we recorded our conversation, I invite you to listen to glean valuable insights on how this year’s jump in crude prices compares with prior oil shocks, why the duration of the disruption matters, which economies may be most exposed, and what indicators our team is watching to assess the ongoing impact on growth, inflation and monetary policy—especially relevant in the event hostilities resume. Please note, however, that S&P Global Market Intelligence currently expects the memorandum of understanding for a cessation of hostilities signed between the US and Iran on June 17 to remain in effect.

Ken and I also discuss why our base case still points to continued global expansion, even as risks remain elevated, and whether the global economy is becoming more resilient. Join us now.

We are going to start with a bit of a history lesson. Ken, how does the jump in crude oil prices in March following the start of the Middle East conflict compare to prior oil price spikes?

Ken Wattret:

That's a really good question. If we focus on the percentage increase in crude oil prices over the month following the start of the conflict in the Middle East in late February, we're talking about an unusually large increase. So for Brent crude specifically, the monthly increase was over 40%. And that magnitude of increase has been exceeded only twice over the history of the series going back to the 1980s. The first time was in August 1990 at the time of the first Gulf War and the second was in May 2020 during the COVID-19 pandemic. Now that second episode was a little different in the sense that crude oil prices were rebounding following a sharp drop when the pandemic initially arrived. In percentage terms, the rise in spring 2020 was quite large, but in dollar terms, it was comparatively small as the level of prices was rather low at the time because of the pandemic. The bottom line is that the rise in March this year was very large, and that reflects the significance of a conflict in the region to global energy supplies.

Kristen Hallam:

Ken, in your FAQ report, you wrote that comparing oil price changes over just 1 month may not fully capture the magnitude of the shock. What would be another way to capture that magnitude and put it in perspective?

Ken Wattret:

I think there are a few issues to consider here. One is the potential for short-term volatility in commodity prices, including oil in this instance during periods of very high geopolitical uncertainty. Now we know crude prices jumped in March, but if the conflict in the Middle East had come to a relatively swift conclusion and prices came down quite quickly, the macroeconomic consequences would have been relatively short-lived and moderate. Now in this instance, of course, that hasn't been the case. The elevation of crude oil prices has continued because the disruptions to production and supply have continued. And the concern that we're increasingly hearing from our colleagues in S&P Global Energy is that even if the current ceasefire holds, and an agreement to end the conflict is achieved, it's still going to take some time for production and supply conditions to normalize. And that means prices will remain high for quite some time. And it's that duration of the shock that really matters when we're thinking about the economic consequences. Now another issue that we need to consider is the distinction between nominal and real oil prices. Measured in real terms, the recent rise in crude oil prices, though large, is somewhat smaller than some of those we've seen during past oil shocks. For example, if we deflate the oil price using the U.S. Consumer Price Index, the price of Brent exceeded $200 a barrel in mid-2008 just before the intensification of the global financial crisis. That's roughly twice the current level. And if we go further back to the late 1970s and early 1980s following the Iranian revolution, the Brent price, again, in real terms, deflated by the U.S. Consumer Price Index, that peaked at around $180 a barrel, which again is well above the current level. So that's a comfort of sorts when thinking about the potentially adverse impacts on global economic growth of the current oil shock, but we still need to be cautious first and obviously, because the current shock is ongoing and prices could rise much further if the supply disruptions continue. And secondly, because the negative growth impact may not just be about the level of oil prices, we may also be running into shortages if the disruptions continue and that could aggravate the negative economic effects.

Kristen Hallam:

Thanks for putting that in perspective, Ken. It is a comfort, but maybe a cold one. So do the effects of prior oil price shocks provide any pointers for the period ahead?

Ken Wattret:

Well, I think there are some lessons that we can learn from prior shocks, but we need to look carefully at what drove the shock, how long it lasted and the economic conditions at the time. So, for example, if we look back at the late 2000s and early 2010s, the price of crude was well over $100 a barrel for a very long time. And that was due primarily to very strong demand from China. But demand conditions elsewhere were very weak, primarily due to a hangover from the global financial crisis. And as a consequence of that, core inflation rates, excluding energy and food, they generally remained rather low. So, the major central banks at the time looked through the persistently high oil price and they kept their policy rates at pretty low levels. Now in the early 2020s, coming out of the pandemic and aggravated by the war in Ukraine, crude prices were again well above $100 a barrel. But on that occasion, although the oil shock was less persistent, core inflation rates rose markedly and the reaction of the major central banks was ultimately very different as a consequence. Now they initially underestimated the magnitude, persistence and breadth of the rises in inflation at the time, and they were quite late in responding. But that meant that when they eventually did realize that this was a major inflation shock, the rate increases that they announced were very large. And one could argue that policy rates reach levels higher than would have otherwise have been the case if they'd have responded sooner. And that may increase the likelihood this time around that some central banks adopt a stitch in time saves 9 approach. And we're already factoring some of that into our forecasts, including for some of the most important central banks like the ECB, where we expect that they will start to raise rates relatively soon because they think if they move more quickly, it probably means that they will contain the inflation shock, contain inflation expectations, and they'll probably have to raise interest rates less substantially as a consequence.

Kristen Hallam:

While we're talking about how different central banks might respond, it might be good to take a more granular look at which economies are most reliant on energy imports from the Gulf.

Ken Wattret:

Yes, that's also a really important aspect of this shock. The economic effects are not uniform. Now I'm pleased to say that we've got lots of data at S&P Global Market Intelligence, which helps us to answer these types of questions. So if we look at the proportion of an economy's oil and gas supplies that come from the Gulf countries as a starting point, the countries that rank highest in that regard are generally located in the Asia Pacific region with countries like Japan and the Philippines at the upper end of the scale and Australia at the lower end. But we need to be cautious about how those high levels of reliance on energy imports from the Gulf translate into economic performance because there are some other factors that we also need to consider. One is the energy mix. An economy may have a relatively high share of its overall imports of gas, say, coming from the Gulf countries, but gas might account for a comparatively small share of overall energy usage. Another consideration is the level of reserves. Many countries in that region and globally have substantial strategic reserves, which they can draw upon. And third, and arguably, this is particularly important, the policy responses. Some governments have quite a lot of fiscal space and they can use it to mitigate the effects of higher energy prices on households and businesses. Also, some central banks may be more inclined to look through the energy shock. Others may be inclined to tighten monetary policy as we've already discussed. And another thing that we need to consider is how economies were generally faring before the energy shock happened. If we look at Western Europe, many of the major economies were really struggling to generate any growth before the conflict began, and that leaves them relatively vulnerable to being tipped into recession.

Kristen Hallam:

So that naturally leads to my next question for you, Ken, which is what indicators of economic health are we watching most closely in these economies?

Ken Wattret:

We're watching a wide variety of indicators. As I already highlighted, there are a range of different factors that we need to consider to determine an economy's sensitivity to an oil shock. To reflect those, we've created vulnerability indexes, which include a wide variety of metrics, including some of those we already discussed, reliance on energy supplies from the Gulf, sensitivity to trade, supply chain disruptions, and so on. And they're a very helpful gauge in identifying which countries are most at risk. We also need to monitor the flow of economic data, obviously, and the purchasing managers indices that we produce each month are very helpful because they tell us almost in real time what's happening to a wide range of different areas of the economy, including output, prices, delivery times, labor market conditions and so on. And since the conflict started, they've consistently indicated that firms’ input costs are soaring. That can take some time to become apparent and official inflation data. So, it's really helpful to have those PMIs giving us a sense of what's happening quickly. Regarding growth trends, as one would expect, given the differences in sensitivities, the impacts in the PMI data have not been uniform so far. Low growth, net energy importing economies in Europe are struggling, whereas net energy exporters like the U.S. show much less economic fallout. At least so far, anyway, we'll have to see how they evolve. And also the PMIs have shown us something that is really important. The PMIs have been telling us that activity in the manufacturing sector is being boosted by precautionary stock building, and that's linked to firms' concerns about broader supply disruptions due to the disruptions related to developments in the Middle East. Now that's really important because that helps us to avoid misinterpreting strength in manufacturing data as a sign of economic resilience.

Kristen Hallam:

All right. So, one more question that's related to the current conflict and the oil shock related to that. So, before the outbreak of the U.S.-Israeli war with Iran at the end of February, you answered this frequently asked question, would an escalating conflict in the Middle East derail the global economic expansion? Could you tell us how you addressed the question then and how you're thinking about it today?

Ken Wattret:

Well, I think the essence of it really is how long the conflict continues, the breadth of the disruptions, and then the various transmission channels through to the economies that we're forecasting. Probably the simplest way to think about the economic effects of conflict escalation is to think about the areas of spending that are affected and then the potential policy levers that could be used to mitigate or in the case of central banks aggravate those negative effects. The most important transmission channel is higher consumer price inflation squeezing household real incomes, in turn, reducing consumer spending because consumer spending accounts for the largest share of GDP for most economies. Now that rise in inflation that we're talking about has a direct impact on household real incomes, but it also has some indirect effects. And one of those is that it leads central banks to have tighter monetary policy than otherwise. And that tightening of financial conditions leads to a broader weakness in demand, which in turn spills over to business investment along with high uncertainty and reduced corporate profits because margins are likely to be squeezed because input costs are soaring. And if you combine lower consumer spending and lower business investment, then typically, the consequence of that is you have weaker trade flows. So if you put all of those effects together, you can then try and answer the original question: Will the economic expansion continue? And the short conclusion in our base case is that it will carry on. Though having said that, we've been revising down our global real GDP growth forecast since February quite markedly, and we're now predicting the weakest annual growth rate since the global financial crisis, if we exclude 2020's pandemic-related drop. So, we're talking about a global growth rate probably below 2.5%, which doesn't sound that bad at face value, but that is unusually weak. Now in terms of how we assess whether we could move from expansion to contraction, global recessions generally are quite rare, but we can use our Global Link Model to try and run alternative scenarios to see how likely that outcome would be. And if we take a very adverse scenario of protracted high energy prices, supply shortfalls, broad-based inflationary effects, widespread central bank rate hikes and probably as a result, major corrections in asset prices, then the expansion would probably be derailed. That's not our base case, but it could be if the conflict and the related disruptions are very protracted. So, we can use that modeling expertise to try and look at the types of circumstances that would lead us to a global recession.

Kristen Hallam:

So, since our base case is still one of global growth, have economies become more resilient to these high levels of uncertainty that we've seen in recent years? You've touched on the pandemic, the war in Ukraine, now we have conflicts in the Middle East and going back even further to the financial crisis, have economies become more resilient?

Ken Wattret:

Well, it would certainly appear to be the case. If we took 2025 as an example, we had continual uncertainty over U.S. trade policy, numerous rounds of tariff announcements, worries about tit-for-tat retaliations. Most measures of trade policy uncertainty were at extreme levels. We've never seen anything like it before. And yet global economic growth surprised to the upside. And there have been lots of different shocks that economies have had to adjust to over recent years. Now one could argue in the case of the tariffs, one of the reasons why global growth remained quite robust was that there was a kind of rowing back from the tit-for-tat escalations. The U.S. administration announced a lot of changes and then backed away from those. So you could argue that the bark was worse than the bite in the end. And so those announcements are having a progressively diminished effect. Another factor has been the strength of AI-related spending and the data that we see there still looks pretty robust. Regarding the current situation and the impact of the oil price shock and disruptions in supply chains and so on. Time will tell as to how resilient the global economy will be. But we do suspect, given the scale and probably the duration of the disruptions that many forecasters and probably some areas of global financial markets are underestimating the potential macroeconomic impact. I think the hope has been for several weeks now that the strait of Hormuz will reopen relatively soon and energy production and supply will return to normal quite quickly. The analysis from our colleagues in S&P Global Energy suggests that's quite unlikely. So even if strait were to reopen quite soon, and that's highly uncertain at this moment in time, it's quite likely that those energy disruptions are going to persist, and it will take a long time, I think, before we see the full effects of that reflected in economic indicators. So yes, there is a good case for thinking economies have generally become more resilient to uncertainty, but that doesn't mean in this case that this shock won't have material economic effects. I think increasingly, it looks like it will.

Kristen Hallam:

So not to sound overly pessimistic or focusing You’ve potential negatives here, but where do you see grounds for caution, Ken? You've touched on this, but what are the main risks to growth? And do you see any potential for further shocks on the horizon?

Ken Wattret:

Well, the obvious primary concern is the one that we've been talking about: failure to reach an agreement to end the conflict, a resumption of hostilities potentially spreading, much more persistent disruptions to energy production and supply, much higher for longer prices and possible shortages and then all of the knock-on consequences that would follow: soaring inflation, higher for longer interest rates, problems in asset prices and so on. But if we look beyond that, there are also some underlying vulnerabilities that we need to be wary of, too. One is the poor state of public finances in many major economies. And there are a few different facets of that, that are important. One is that it means that there's less scope to react in the event of negative shocks. In a different set of circumstances, if public finances were in better shape, governments could do much more to try and mitigate the effect of this oil price shock. Another aspect is upward pressure on interest rates. We've seen sovereign bond yields rise significantly since the conflict began. That's been particularly acute in some markets like the U.K., but it's also a significant issue for many other economies as well because it's not just the level of policy rates that influence the cost of borrowing in an economy, it's also long-term interest rates and spreads between different interest rate products. So there is a tightening of financial conditions already ongoing in that regard, even though policy rates amongst the major central banks have not yet been going up. Another source of concern, which kind of popped up and then died down in late 2025, is the potential for problems in the nonbank financial sector, credit-related problems, defaults and then spillovers to the broader financial sector. And then more of a macro theme would be the increased reliance on AI-driven growth. What you would really want to see the global economy as stable and resilient is broad-based sources of growth. But increasingly, it looks like growth is particularly being driven by AI-related spending. And that's helpful in the short term, but it's important that economies don't become solely reliant on one area because if that then turns, then obviously, the economic situation can deteriorate quite quickly. And the focus when it comes to AI has always been on the potential for a correction in equity prices, and that's obviously a source of potential risk. But I think it's a bit more than that. It's also about where global growth is coming from.