Weekly Buzz: What higher energy prices could mean for the global economy

The conflict in Iran has put the Strait of Hormuz, the narrow waterway that carries roughly a fifth of the world's oil supply, at the centre of the market's attention. Oil and gas prices have moved higher, but the question now is whether these higher prices last.

What’s going on here?

Short price spikes tend to fade within weeks as markets adjust. If oil and gas prices stay elevated for months, however, the effects start to spread: higher inflation, rising business costs, and broader pressure on financial markets.

Countries that import large volumes of oil, like Japan, India, South Korea, and much of Europe, will feel the pinch first. Higher oil prices drive up fuel and transport costs, which filters through to everyday goods and the cost of living.

That said, the global economy is less energy-intensive than it used to be, which helps soften the impact of energy price shocks. Economies today generate far more output per unit of energy than they did decades ago, thanks to efficiency gains, new technology, and the rise of service sectors. Global supply is also more diversified, with production spread across a wider range of countries than it was during earlier oil crises.

What’s the takeaway for investors?

Higher oil and gas prices matter, but the drag on global growth should be smaller when compared against past oil crises. Whether this proves to be a temporary spike or a more prolonged shock will determine how deeply the effects reach across the global economy and financial markets.

(For a deeper dive on the impact of conflicts on markets, stay tuned for our next CIO Insights) 

This article was written in collaboration with Finimize.

In Other News: Three central banks, one energy problem

Higher energy prices are doing more than raising costs at the pump – they’re also reshaping the interest rate outlook for central banks. The European Central Bank (ECB) and the Bank of England (BoE) are both expected to hold interest rates steady when they meet this week, but the market is less sure about how things might go after that.

Traders were expecting the ECB to keep borrowing costs flat all year, but now they’re pricing in at least two rate hikes, which would mark the end of the ECB's rate-cutting cycle.

The logic is simple: Europe relies heavily on imported oil and natural gas, so an increase in energy costs will quickly feed into consumer prices. Policymakers will want to knock down those pressures early. The UK’s in a similar spot, and traders have gone from pricing in two rate cuts from the BoE to pricing in a possible hike.

Then there’s the Bank of Japan (BoJ). It’s been the outlier among major central banks: while others have lowered rates, it’s been pushing them higher. The BoJ’s expected to keep borrowing costs unchanged, but traders will be watching for signs of faster rate hikes ahead. Japan imports a lot of its energy and food, making it exposed to the same dynamic.

(For a portfolio that’s built for wherever interest rates go next, see General Investing.)