Global markets react to the Middle East conflict

Over the past several weeks, global financial markets have shifted noticeably amid intensified conflict in the Middle East. Since late February and early March, the economic backdrop has shifted from steady improvement to a more uncertain environment shaped by geopolitical tensions.

From our perspective at Australian Financial Planning Group, markets had entered this period in relatively good health. Inflation was easing, growth was broadening across regions, and central banks were beginning to take a more measured approach to interest rates. However, the escalation involving Iran, following US and Israeli strikes, has introduced a new layer of complexity that investors can’t ignore.

At the centre of the concern is energy. The Middle East remains critical to global oil supply, particularly through the Strait of Hormuz, which accounts for around 20% of global oil flows. Any disruption here has immediate consequences. We’ve already seen energy prices lift, and this flows through to transport costs, manufacturing, and ultimately household expenses. In simple terms, higher oil prices can quickly translate into renewed inflation pressures.

This is where the global response becomes important. Central banks, particularly in the United States, have so far shown restraint. The US Federal Reserve has kept interest rates steady, signalling it wants clearer evidence that inflation is under control before making any adjustments. Inflation itself has been trending lower, with US consumer prices easing to 2.4% annually, while unemployment remains stable. That combination has helped support spending and economic activity.

At the same time, global growth has not been confined to one or two economies. We’ve seen encouraging signs from Japan, the UK, and parts of Europe, while China has delivered stronger-than-expected data, particularly in exports and industrial production. This broader base of growth has provided some resilience, even as geopolitical risks increase.

That said, the current environment is no longer being driven purely by economic fundamentals. Markets are now responding to a mix of improving data and rising uncertainty. We are seeing periods of confidence interrupted by bouts of caution, particularly as headlines around the conflict evolve.

Here in Australia, the situation is slightly different. While many major economies are holding or considering easing interest rates, the Reserve Bank of Australia has moved in the opposite direction, lifting rates to 3.85%. This reflects ongoing strength in consumer demand and a tight labour market. The RBA is focused on ensuring inflation does not become entrenched, particularly through wages.

For Australian households and investors, this creates a challenging combination. On the one hand, global uncertainty is raising costs, particularly in energy. On the other hand, domestic interest rates remain relatively high. This puts pressure on borrowing costs, mortgage repayments, and business investment.

We are paying close attention to how these forces interact. One key area is inflation. While headline inflation has eased, underlying cost pressures remain. For example, wholesale prices in the US have recently picked up, suggesting that cost increases may still flow through to consumers over time.

We are also monitoring the strength of the US economy. While parts of the labour market have softened, the services sector continues to expand. This mixed picture makes it harder to predict how quickly interest rates may eventually come down.

Our central expectation is that the global economy continues to grow, but at a more cautious pace. The foundation remains solid, supported by government spending, corporate earnings, and ongoing investment in areas such as artificial intelligence, energy infrastructure, and supply chain resilience. However, the longer the Middle East conflict persists, the greater the risk that higher energy costs begin to weigh more heavily on growth.

There are, of course, alternative outcomes. If tensions escalate further and oil prices rise significantly, we could see a more difficult environment in which inflation rises while growth slows. This would limit central banks’ ability to provide support and would place additional strain on households and businesses.

On the other hand, if the situation stabilises more quickly than expected, energy prices could ease, supply chains could improve, and confidence could return. In that scenario, global growth would likely strengthen, providing a more supportive backdrop for investors.

For now, we believe it is important to remain measured and adaptable. Markets are adjusting to a new phase where geopolitical developments play a larger role in shaping outcomes. Short-term fluctuations are likely to continue, but the broader economic picture is not without support.

As always, we will continue to monitor developments closely and assess their implications for Australian investors and the domestic economy.

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