Quick Bites | IMF Warns of Global Downturn if War Lasts

• The IMF reduced its global growth forecast to 3.1% from 3.3% in January, warning a prolonged Middle East conflict could slash growth to 2%.

• The IMF issued three scenarios: the “adverse” projects 2.6% global growth with $100 oil, and the “severe” projects 2% growth.

• The IMF lowered 2026 growth projections for the Middle East to 1.9%, Europe to 1.1%, and China to 4.4%, but said the US will fare better.

• The IMF urged the Albanese government to avoid untargeted cost-of-living relief measures which fuel inflation.

The International Monetary Fund (IMF) warned in its latest set of forecasts that a prolonged Middle East conflict could slash global growth to rates seen only in the deepest recent recessions.

Source: Financial Times

Already, the war has been more disruptive to global energy markets than the 1973 oil crisis, the IMF’s chief economist, Pierre-Olivier Gourinchas, said in an interview. He warned that if the disruptions persist beyond this year, even after the US and Iran reached a fragile cease-fire last week, world economic growth could fall to about 2% in 2026, a sluggish rate seen only during the deepest recent downturns.

“Every day the clock is running, it gets bigger and bigger,” Gourinchas said of the economic risk.

The IMF’s latest report takes the unusual step of issuing projections for three scenarios: a “reference,” “adverse” and “severe.”

In the reference scenario, the conflict resolves promptly yet still places a drag on the global economy. In that outcome, oil would average about $80 a barrel this year, and global output might grow 3.1% on a year-over-year basis, the IMF projected. That is down from the 3.4% growth recorded last year, and lower than the 3.3% the IMF projected in January.

In their adverse scenario, which assumes that the war persists but ends later this year, oil prices spend much of the year around $100 a barrel, global growth might fall even farther to around 2.6%. Global inflation would rise to 5.4%.

And in a severe scenario, in which the war continues into next year and keeps oil prices high, the global economy could slide into an even deeper downturn, the IMF projected.

Source: WSJ

The IMF didn’t assign probabilities to the three scenarios, which were completed before the US and Iran reached a cease-fire. Gourinchas said the breakdown of US-Iran negotiations in Pakistan lifted the risk of the adverse or severe scenarios.

So far this year, crude prices have averaged about $80 a barrel. Brent crude closed Monday at $99 a barrel as the US began a blockade of the Strait of Hormuz.

Source: FT

The pain from an extended war would fall unevenly across the globe. Based on the disruptions felt to date, the IMF lowered projected 2026 growth in the Middle East by 2% to 1.9%. It also dropped projected growth in Europe by 0.2% to 1.1%, and by 0.1% in China, to 4.4%.

Emerging-market economies that rely on fuel imports could face some of the biggest challenges, the IMF said.

The US, buoyed by its large energy industry and its dominant role in the artificial intelligence build-out, will likely fare better, in the IMF’s view. It cut American growth in the reference scenario by just 0.1% to 2.3%, compared with the January outlook. But if the war goes on, central banks such as the Federal Reserve could quickly face a trade-off between keeping inflation in check and supporting a fragile economy, Gourinchas said.

High inflation earlier in the 2020s has left policymakers sensitive to perceptions that they are too tolerant of rising prices, so any hint of additional inflation could prompt interest-rate hikes. “Of course, that’s going to be painful,” Gourinchas said.

The global economy still has important supports that could mitigate the damage from the war. Many governments, including the US’s, have been cutting taxes while spending liberally. Trade tumult ignited by the Trump administration’s tariffs last year might prove less disruptive in 2026. Investment in artificial intelligence is supporting a surge of infrastructure construction, and the technology could improve economic productivity.

Still, the risks of a downturn are more substantial than the possibility of a surprise upswing, according to the IMF’s forecasters. The longer the war continues, the more likely it will contribute to global food shortages, political instability and pain in financial markets.

Chalmers warned about budget’s impact on inflation

The IMF cautioned against untargeted cost-of-living relief, such as the Albanese government’s recent decision to halve the fuel excise to 26.3¢ a litre which will cost it $2.55 billion in forgone revenue. It said while such policies are popular, they are “poorly designed and costly” and could contribute to further inflation.

“Preserving price signals is important: high prices signal scarcity, encouraging demand restraint and supply expansion. Price controls … cannot change that fact,” the IMF said. “Worse, such measures often backfire by raising underlying prices, leading to rationing.”

The IMF said this was particularly important for governments with elevated budget deficits and rising public debt. Australian gross debt is set to pass $1 trillion later this year, and the budget is forecast to remain in deficit for a decade.