What is the cost to the economy of Israel's attack on Iran?

Independent

19 hours ago

If we needed another lesson about the difficulties of managing an economy in a period of nerve-wracking uncertainty, Israel's attacks on Iran have provided it.
Market reaction to Israeli 200 fighter jets hitting more than 100 targets was swift – and predictable. The oil price shot up, the gold price shot up and share prices tumbled across the world.
The FTSE escaped the worst of the damage, largely because of its substantial contingent of natural resource stocks, including the presence of two heavily weighted oil majors in its upper reaches. But it still gave up ground following its record close.
Economic institute DIW has warned that higher oil prices resulting from the hostilities will hurt the German economy, Europe's economic engine – and the impact will not be confined there. Britain is in the midst of a moderate inflationary spike, with rates jumping to 3.4 per cent in April (3.5 per cent officially, but the Office for National Statistics got its sums wrong and has decided not to course correct).
The jump in prices, created by an oil slick of bill, fare and tax increases in that month, is at least expected to be temporary. But higher fuel prices have the potential to change that by powering up prices, potentially leading to a higher and longer-lasting spike than had been expected.
The Bank of England has no control over the international price of oil. However, history tells us it will act to damp down what it describes as the 'second order effects' from pricier oil fuelling inflation.
That is a problem for the UK economy – and chancellor Rachel Reeves, while we're at it – because they could really use the helping hand of lower interest rates. Donald Trump's tariffs are hurting exporters and even though there have recently been signs that the trade deal secured by Keir Starmer will take effect soon, the base 'liberation day' 10 per cent levy will still largely apply to British exports.
While this still leaves the UK in a relatively favourable position, the impact of the much higher tariffs on those without the (relative) benefits of a Starmer-style deal will still hurt. The US remains the world's biggest economy. Trump's economic vandalism will obviously damage the wider global economy, constricting trade, reducing growth, adding to the crippling uncertainty that many investors are apt to react to by hiding under their beds with pots filled with as much gold as they can afford.
Companies can be expected to respond similarly if the hostilities continue: when CEOs hear war drums beating, they are apt to switch their focus from risk taking and investment to cost cutting and cash conservation until the turmoil has passed.
In recent days, hopes of more UK interest rate cuts have been rising. The economy's struggles in April, which recorded the sharpest contraction in two years, the fact that inflation is actually lower than the ONS said it was and the marked weakening of the labour market, with unemployment rising, job openings vanishing and wage settlements falling, are food for those calling for looser monetary policy, including your correspondent.
Traders had been betting on two more cuts, with the first coming in September. Israel's action, however, could shift the calculus again, certainly if it the immediate rise in oil prices is sustained.
The Bank's rate setting Monetary Policy Committee (MPC) is not expected to move when it meets next week but, as ever, the comments in the minutes and the way the vote goes will merit close attention.
Swati Dhingra will, as she typically does, take a dovish line. I would expect her to vote for an immediate cut. The big question is whether any of her colleagues on the nine-member MPC will join her.
The uncertainty created by the outbreak of yet more hostilities is probably all the reason the majority will need for sitting tight and waiting to see how this plays out, before assessing the impact on inflation and the economy .
For the rest of us, by which I mean those of us lucky enough to have savings and investments, the message is, well, sorry to descend into cliche, but keep calm and carry on.
That meme, modern cliche and merch marketing tool – even though the faux wartime nostalgia of said merch is completely fake – represents sound advice.
The markets are apt to panic when things like this happen. Traders who play an important role in price formation, exhibit herd like behaviour, even though this about the worst possible response. It was ever thus. But that doesn't mean we have to follow suit. Much better to sit tight and hope (pray?) that it blows over soon.