War and Inflation

The effect of Israel, Iran and others

Various stock markets have taken a bit of a dive due to the war in the Middle East recently and I thought it was worth some consideration about how things could play out.

I suppose the big concern is a wider war and the effect on oil prices and inflation, especially given reports of the UK, US and others providing military support to Israel in defence of Iran's attack.

So How Far Could The War Spread?

It's easy to imagine Russia supporting Iran as Iran has been providing military assistance to Russia's invasion. If Russia end up in a war against the US and Europe, that could trigger China to side with Russia, as they've previously suggested they would.

What's More Likely?

Well, Russia (rather, Putin) only wants to appear strong to the Russian people. Other than invading the Ukraine, they don't want all out war for the fun of it. They also don't want nuclear war, but will threaten that so foreign powers don't interfere and make them look weak to their people. Putin also doesn't want to cause too much suffering that could trigger a revolt.

Russia may be obliged to help Iran, but they won't want to fight NATO's forces directly because they won't want to force NATO into war with them, which would also change their game in the Ukraine. Instead we have a situation whereby a country invades another, allies provide military "assistance" (troops, etc.) and the allies of the invaded provide military "support" (just hardware and aid) so they aren't engaging in war.

Most likely I think that countries with obligations to warring countries will provide support, rather than assist. I think that NATO has assisted Israel to force opposing countries into a weaker "support" position rather than one of "assistance" (which is basically a role reversal in the Ukraine, where Russia has assistance from Iran but NATO can only support Ukraine).

So, outside of the Middle East, I don't see this becoming a wider war. Nevertheless, "support" from wider countries also extends into the political and economic realm, which includes issues of oil (Iran is the 7th largest producer of oil in the world. Russia is also one of the biggest producers). We're also seeing a growing no-fly zone and danger zone for sea freight, which will affect shipping prices.

In summary, I see increased inflation risk, which will likely put downward pressure on stock markets due to potential increase cost of doing business (translating to lower profits) and increases to the OCR (and therefore the risk free cash rate, which will change valuations to the pessimistic side). Increases to the OCR will also negatively affect property prices.

How likely is the OCR or inflation to increase? I don't know, but there are definitely upward risks appearing from the Middle East, which previously weren't present. I’d love to hear your opinions in the comments.