OECD: Middle East conflict could significantly drive up U.S. inflation; the global economy faces downside risks

On Thursday, March 26, local time, the Organization for Economic Co-operation and Development (OECD) released a report stating that if conflicts in the Middle East lead to further increases in energy prices and these remain high for an extended period, global economic growth will be impacted, and U.S. inflation will rise significantly.

In the latest Economic Outlook, the OECD sharply revised upward its inflation forecasts for major economies. It now expects the G20’s average inflation rate to rise to 4% this year, significantly higher than the 2.8% predicted in December last year. U.S. inflation is expected to be even higher, raised from 3% to 4.2%, exceeding the Federal Reserve’s target inflation rate by more than double.

The OECD also raised the inflation forecast for the UK from 2.5% to 4%; for the Eurozone from 1.9% to 2.6%; and for Japan from 2.2% to 2.4%.

The OECD is the first major international economic organization to officially update its forecasts. Other indicators, such as business surveys, have already begun to show a synchronized global impact: weakening economic activity and rising prices.

Global Economy Faces Downward Risks

The OECD pointed out that despite U.S. President Trump’s tariffs increase last year, the global economy showed resilience beyond expectations. Originally, it forecasted that, driven by increased AI-related investments and falling interest rates, global economic growth this year could be revised upward from 2.9% to 3.2%.

However, at the end of February this year, the U.S. and Israel launched a series of strikes against Iran, triggering conflict, causing widespread damage to energy and transportation infrastructure, and nearly closing the Strait of Hormuz. This strait accounts for about one-fifth of global oil transportation, as well as a significant share of natural gas and fertilizer trade.

The OECD states that without this conflict, it could have raised the 2026 global growth forecast by 0.3 percentage points. Currently, it maintains the forecast at 2.9% and has slightly lowered the 2027 growth projection by 0.1 percentage points to 3%.

The organization warns that if energy prices remain high, global economic growth this year could be only 2.6%, more than 0.5 percentage points below pre-war expectations, with even greater negative impacts on 2027.

Regionally, the OECD raised the U.S. 2026 growth forecast from 1.7% to 2%, mainly driven by the AI boom; meanwhile, the Eurozone’s growth outlook was lowered from 1.2% to 0.8%.

Among the 20 economies covered in the OECD report, the UK saw the largest downward revision, with its 2026 growth forecast lowered from 1.2% to 0.7%.

Central Banks May Not Need to Hike Rates to Tackle Inflation

The sudden change in the economic environment may force policymakers to adjust their stance. The Federal Reserve hinted last week that a rate cut is unlikely in the near future. Meanwhile, markets are beginning to consider the possibility of rate hikes by the Fed this year.

For the European Central Bank, policymakers are considering the earliest rate hike in April.

Nevertheless, the OECD expects that as energy prices fall back to pre-war levels by 2027, inflation will cool again, and it believes that central banks may not need to raise rates significantly to counteract this potentially temporary inflation increase.

The report states: “If inflation expectations remain stable, the current rise in global energy prices driven by supply shocks can be ‘ignored,’ but if broader price pressures or signs of labor market weakness emerge, policy adjustments may be necessary.”

The OECD forecasts that the Federal Reserve will keep interest rates unchanged this year and next; the European Central Bank may implement a “moderate” rate hike in the second quarter to ensure inflation expectations remain stable.

(Source: Caixin)