Geopolitics is front and centre

This week we witnessed a number of geopolitical events, ranging from the escalating war in the Middle East to a port strike on the East Coast of the US (now temporarily resolved), to the election of the first woman president in North America . The economic reverberations of geopolitical events are often difficult to calibrate, and economists often prefer to exclude politics from their modelling. At EIU, we specialise in both conducting this calibration and modelling scenarios on which our clients rely to make critical decisions for their businesses.

Over the past few weeks the long-running but largely contained conflict in the Middle East has escalated markedly. With Hizbullah attacking Israel with rockets since last October in support of Hamas, in the past week Israel has taken precise steps to eliminate Hizbullah’s leadership, including assassinating its revered leader and close ally of Iran, Hassan Nasrallah. The response from Iran, measured though it was, suggests that the risk has increased, despite Iran stating that there would be no further attacks unless Israel retaliated. We believe that Iran wants to avoid a further escalation, as do the US and its allies in Europe and the Middle East.

At this juncture, the risk lies mostly in the scope of Israel’s actions. We assign a 60% probability to a partial de-escalation, 20% to a major escalation and 20% to a successful de-escalation.

• A partial de-escalation would involve a war of attrition between Israel and Hizbullah, conducted mostly in Lebanon, as Israel seeks to push the group back north of the Litani River and thereby reduce its capacity to easily target northern Israel. The only way to avoid this would be a peace deal in Gaza, negotiations for which will drag into the first quarter 2025. Meanwhile, the Houthis would continue to launch sporadic missile?strikes at Israel, bringing further retaliatory air strikes on their infrastructure in Yemen. Similarly, various Iraqi militias would launch sporadic but ineffective attacks. This would keep the Suez Canal largely closed as a shipping route and raise the risk of accidents or miscalculations that lead to a major escalation. Likewise, the toll of a war of attrition could push the parties to negotiate a de-escalation.
• A major escalation would necessitate large-scale Israeli missile strikes on Iranian energy infrastructure, including—possibly—its nuclear facilities. Iran could respond with further large-scale strikes on Israel, and authorise Hizbullah to launch its Iranian-supplied stash of missiles at Israel. This would widen the conflict and require greater direct involvement from the US, which the US is presently unwilling to undertake. However, the situation is fluid, and conversations behind the scenes are ongoing.
• A de-escalation would require massive international diplomatic efforts to be brought to bear on Israel, Hamas, and Iran and its proxies. For this to be acceptable to Israel, a deal would probably need to be reached in Lebanon to implement UN Security Council Resolution 1701, which calls for the demilitarisation of southern Lebanon. An additional necessary component would be a peace deal with Gaza that removes the stated rationale for attacks on Israel by Hizbullah, the Houthis and other Iran-aligned regional militias in Iraq and Syria.

The spot oil market had been reacting as if there would be partial de-escalation, with only a muted rise in prices. Remarks from the US president, Joe Biden, which suggested that the US was discussing potential support of Israel attacking Iran, were enough to send prices up by nearly 5% on October 3rd, demonstrating the hair-trigger sensitivity of the situation. We would expect the spread of dated Brent Blend over West Texas Intermediate (WTI) to widen above its current US$5 level. We are closely monitoring these global geopolitical events, and provide regular updates to our assessment of their economic impacts to our Viewpoint subscribers.

Find out more here .

Constance L Hunter

Chief economist

EIU

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