How the Middle East conflict is repricing global growth: inflation, interest rates, and capital reallocation in the eyes of the OECD

How the Middle East Conflict Is Repricing Global Growth: Inflation, Interest Rates, and Capital Reallocation in the Eyes of the OECD

The OECD’s latest assessment offers a global macroeconomic proposition that is not unfamiliar, yet increasingly difficult to ignore: when geopolitical conflict directly affects energy supply, the global economy is no longer merely experiencing “short-term volatility,” but may enter a more enduring repricing process. At its core, this is not just about rising oil prices, but about growth, inflation, monetary policy, trade routes, and capital flows being forced to be rearranged at the same time.

Under the baseline scenario, the OECD expects global growth to slow from 3.4% in 2025 to 2.8% in 2026, before rebounding to 3.1% in 2027. These figures do not in themselves indicate a recession, but they reveal something more important: the global economy is moving from the post-pandemic recovery phase into a stage that is more sensitive to external shocks, more dependent on policy, and more tolerant of regional divergence. So long as the war does not evolve into lasting supply destruction, the world economy can still maintain expansion; but once energy disruptions persist into next year and beyond, global growth could fall significantly to 2.1% and 1.8%, approaching the low-growth zone typically seen only during major crises.

This is not a simple cyclical pullback, but the return of risks from resurgent supply-side inflation. The OECD notes that if the energy shock persists, global inflation could rise by an additional 0.4 percentage points in 2026 and 1.3 percentage points in 2027. This means that the inflation central banks spent the past two years trying to suppress has not disappeared; rather, it has been temporarily dampened by energy, logistics, and expectations, yet remains capable of being reignited by geopolitical events. For policymakers, this kind of inflation is more troublesome because, unlike demand overheating, it cannot be curbed solely through interest-rate hikes. On the contrary, if rates are raised too quickly, the downside risks could be amplified in an already fragile growth environment.

Accordingly, the OECD expects that if energy prices remain elevated for an extended period, major central banks around the world may raise interest rates by 0.5 to 0.75 percentage points in the short term. The implications of this judgment go far beyond a technical adjustment. It shows that global monetary policy is entering a more asymmetric phase: when the shock comes from supply rather than demand, central banks often face a dilemma—if they remain relatively accommodative, inflation expectations may become unanchored; if they tighten further, financial conditions deteriorate, corporate financing costs rise, and fiscal sustainability comes under pressure. In other words, the interest-rate cycle is still intact, but it is increasingly no longer centered on a single set of US inflation or employment data; instead, it is being passively recalibrated amid the global energy chain and geopolitical risks.From the perspective of international capital flows, such shocks often reinforce “safe asset preference” and “regional reallocation.” When markets expect a conflict to persist, capital usually first flows toward economies with stronger liquidity, higher net energy gains, and more resilient external financing. In its report, the OECD suggests that the United States may partly offset the drag from weakened household purchasing power thanks to improved energy exports; by contrast, Asian economies with high dependence on Middle Eastern energy are more likely to face a double hit from rising import bills and deteriorating terms of trade. This means global capital is not contracting evenly, but is being re-segmented across different regions.

This divergence is especially evident in the eurozone, Japan, and some Asian economies. Eurozone growth is expected to slow from 1.4% this year to 0.8%, then recover to 1.2% next year, driven by a relatively resilient labor market and higher defense spending, rather than a strong rebound in domestic demand. Europe’s structural problem still lies in manufacturing competitiveness and limited fiscal space: when energy price volatility coincides with fiscal tightening, it is difficult for growth to gain sustained support from the private sector. The situation in the UK is similar: growth is projected to slow to 0.9% this year and not rebound to 1.1% until 2027, indicating that stable global trade and looser financial conditions remain prerequisites for recovery, rather than a natural revival in domestic demand.

Asia presents a more complex picture. China is expected to slow from 5.0% in 2025 to 4.5% in 2026, and 4.3% in 2027. The OECD specifically notes that ample energy reserves mean its exposure to oil price shocks is relatively limited, but the downturn in the property sector remains a drag. What is worth noting here is that a key variable in the global economy is shifting from “imported energy shocks” to “energy shocks plus balance sheet repair.” In other words, even if an economy can withstand external oil price increases, if its domestic property sector, local government finances, or corporate debt have not yet fully cleared, external shocks will still be amplified through credit channels.

Japan, meanwhile, may become one of the more sensitive economies under the dual disturbance of trade and energy. The OECD projects its growth to fall from 1.1% in 2025 to 0.6% in 2026, before edging back to only 0.8% in 2027. More importantly, Japan needs a “clear and credible” medium-term fiscal consolidation plan, because as interest rates rise, the fragility of public finances will gradually become more apparent. This is an important signal in the global long-term cycle: after years of ultra-low interest rates, highly indebted economies are returning to an era of “interest rate normalization and reassessment of fiscal constraints.” The war itself may not permanently alter Japan’s growth potential, but it will raise debt financing costs and force markets to reassess the risk premium on sovereign assets.Global trade, too, is no longer merely a question of efficiency, but increasingly one of security and resilience. The OECD believes that global trade growth, after being robust in 2025, will slow, but resilient demand for AI-related goods and investment, especially in Asia, will still provide some support. This is highly characteristic of the era: as traditional consumer and manufacturing cycles weaken, the AI investment chain is becoming one of the few sources of capital spending still capable of global diffusion. Demand for semiconductors, data centers, power equipment, and related industrial goods is creating a new branch of support for trade. In other words, global trade has not returned to the old path of liberalization; instead, it is being reorganized amid geopolitical security, technological upgrading, and regional industrial policy.

If the key words of the past decade were “low inflation, low interest rates, low volatility,” then the current period is closer to one of “high shocks, divergence, and repricing.” Geopolitical conflict has brought energy prices, inflation expectations, and monetary policy back onto the same main track, exposing a deep shift in the global economic system: supply-side uncertainty is rising, while policy buffers are shrinking. The fiscal expansion after the pandemic has already consumed a considerable amount of policy ammunition, and major central banks are still trying to find a balance between suppressing inflation and supporting growth. In this environment, external shocks are no longer merely temporary events, but more like stress tests of the resilience of the global economy.

Looking further ahead, this also means that global capital allocation will continue moving in three directions: first, energy security will take priority over minimum cost; second, supply chain resilience will take priority over extreme efficiency; third, economies with stronger fiscal and external balances will receive lower risk premiums. For emerging markets, this shift is especially important. Those that rely on energy imports, have high external debt ratios, and limited monetary policy space are often the first to come under pressure when oil prices rise and dollar financing conditions tighten. They must absorb imported inflation, guard against capital outflows, and avoid currency depreciation from pushing inflation up again.

Therefore, what this OECD assessment is truly warning markets about is not whether the Middle East situation will immediately trigger a global recession, but whether the global economy has already entered a stage that is more vulnerable to geopolitical shocks. The answer is likely yes. As energy, fiscal policy, trade, and monetary policy become increasingly intertwined, the future global cycle will be driven less and less by a single demand variable, and more and more shaped by supply security, geopolitical risk, and policy constraints. For researchers and policymakers, this means growth must be understood through a new framework: not simply asking whether the economy will slow, but asking, in a more fragmented world, who can still sustain growth at lower cost, and who will be forced to spend down policy space prematurely in the face of shocks.

ConclusionThe impact of the Middle East war on the global economy is not as simple as oil prices rising by a few percentage points. It is bringing a deeper issue to the forefront: whether the low-cost, high-efficiency, low-inventory system built in the era of globalization is still sufficient to cope with a more unstable world. The OECD’s answer is not optimistic, but it is clear enough — if the conflict becomes prolonged, the global economy will face the triple pressures of lower growth, higher inflation, and tighter policy, which is precisely a sign that the global economic cycle is changing.