Oil near $100 poses renewed threat to central banks

Entering the new week, a return to $100 oil appears imminent. Markets should be more alert this time.

A preview occurred between March and May. Now, more than six months have passed since the US-Iran conflict flared and tensions rose again. The greater concern is the apparent lack of will to de-escalate now.

Traffic through the Strait of Hormuz remains nearly halted, regardless of Trump's statements or any back-channel efforts. The longer this continues, the greater the risk of further disruption to oil supply-demand balances.

Whether oil reaches $100 is almost irrelevant. The key issue is the consequences if it remains there for an extended period while the war persists.

Oil above $100 endangers the inflation outlook.

This is nearly certain and has already appeared in summer inflation data.

A fresh energy shock is emerging as crude gains push up petrol, diesel, jet fuel, and transport expenses. The primary fear is that this will cascade into other sectors.

Central banks had a respite after the March-May oil spike, but now face renewed pressure. A sustained energy shock could undo years of work to bring inflation under control.

Headline CPI will reflect the initial effect. But policymakers will focus on subsequent developments.

The true risk lies in secondary impacts.

Central banks have attempted to avoid basing policy on temporary disruptions. They have not changed course during the geopolitical crisis, which is appropriate.

Higher rates cannot produce more oil to fix the supply problem.

However, when necessary, they must act on their mandate. That is where the complication deepens.

A trucking firm facing higher diesel costs might raise delivery fees. Airlines with expensive jet fuel could increase ticket prices. Manufacturers may shift higher transport and power costs to customers.

Workers then seek higher wages to offset increasing living expenses.

What starts as an oil shock soon shows up in services inflation, wages, and expectations. That is when central bankers become uneasy and policymakers grow concerned.

Central banks confront a policy quandary.

With $100 oil back on the horizon, markets and central banks face increased tension.

If crude drives inflation up and growth stays strong, central banks have an easy choice: maintain tight policy or raise rates.

The difficulty arises when $100 oil significantly weakens growth. For example, households have less disposable income as fuel and power costs rise. Business margins shrink, consumption declines.

That scenario brings higher inflation alongside weaker growth — the stagflation narrative returns.

Policymakers must fulfill their mandates, but that could push the economy into recession if conditions stay unchanged for six to twelve months. At what point does the pain become intolerable?

The calculation for wider financial markets is shifting.

Over the past half year, equity markets and broader financial assets have largely shrugged off the US-Iran tensions.

Investors previously ignored the specter of $100 oil and might do so again.

But as noted, the issue is not whether oil reaches $100, but whether it holds that level over an extended period.

Bond markets already show strain, and financial conditions will tighten further. High inflation and elevated rates combined with economic weakness typically hurt equity performance.

Thus, the danger is not oil reaching $100, but it staying high long enough to prompt investors to reassess the factors supporting risk assets.

Each day the US-Iran conflict persists, that danger grows.