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What a US-Iran war could mean for the economy

An escalation of hostilities after a U.S. airstrike killed a top Iranian military commander could send shockwaves through the global economy, according to analysts. 

“The assassination of Qassem Soleimani, a major figure in the Iranian regime, in a U.S. airstrike last night has significantly raised the chances of an outright conflict between the U.S. and Iran,” Jason Tuvey, senior emerging markets economist for Capital Economics, wrote in a note Friday. 

“Our central scenario is that the global economy will bottom out in the early part of this year and recover thereafter,” he added. “But the outbreak of war between the U.S. and Iran would put the recovery on ice.” 

Qassem Soleimani, head of Iran’s Islamic Revolution Guard Corps’ Quds Force, was killed by an airstrike in Baghdad ordered by President Donald Trump, the Department of Defense said in a statement Thursday.  The Defense Department said that Soleimani was actively planning to attack American personnel in the region.

Iran’s Supreme Leader Ayatollah Ali Khamenei vowed to inflict “severe retaliation” on those involved in Soleimani’s death, according to a statement cited by media.

“Clearly, the major concern for the world economy is that events spiral out of control and the U.S. launches a full-blown military assault on Iran,” Tuvey said. “The resulting collapse in Iran’s economy could knock as much as 0.3%-pts off global GDP – equal to our estimate of the damage from the US-China trade war.” 

The Iranian-owned Sabiti oil tanker is seen sailing in the Red Sea, October 11, 2019. Picture taken October 11, 2019. National Iranian Oil Tanker Company via WANA (West Asia News Agency) via REUTERS.

The developments rattled global markets, sending Brent crude oil futures (BZ=F) about 4% higher in the immediate aftermath. Haven assets including gold and Treasuries surged, while U.S. stock futures tumbled in early trading.

Rising oil prices is a consumption tax 

The more important impact for the rest of the world, however, would be a protracted spike in oil prices. 

“Our base case here is that a full-blown war between the U.S. and Iran is unlikely,” Ian Shepherdson, chief economist for Pantheon Macroeconomics, wrote in a note Friday. “The infrastructure of the oil sector, though, is a likely target in the event of tit-for-tat escalation.” 

In one possible method of retaliation, Iran could try to close off the Strait of Hormuz, a key passageway for more than a fifth of the world’s global petroleum liquids consumption and a region the U.S. Energy Information Administration has called “the world’s most important chokepoint.” The country has previously threatened to disrupt shipments in the Strait of Hormuz in response to U.S. attempts to choke the Iranian economy. 

In that scenario, Tuvey expects Brent crude prices would rally to $150 per barrel – pushing inflation up by some 3.5-4.0 percentage points in OECD countries, Tuvey said.

And as Shepherdson noted, higher oil prices create “a tax on oil consumers and a windfall for producers.” 

“World oil consumption is about 100M barrels per day, so each five dollars on the prices is equivalent to an annualized tax of about $183B per year, or 0.1% of global GDP,” he said. 

However, the likelihood that the Federal Reserve would respond to oil price-driven inflationary increases with higher rates remains slim, he said, “given their understanding of the impact of higher oil prices, the tightness of the labor market and the coming increase in core inflation from tariff pass-through and a run of adverse base effects.” 

“The wild card is whether turmoil in the Middle East triggers a sustained sell-off in equities, depressing business and consumer confidence to the point where labor market and inflation concerns become secondary,” Shepherdson said. 

Emily McCormick is a reporter for Yahoo Finance. Follow her on Twitter: @emily_mcck

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