Despite major trade disruptions and policy uncertainty, last year ended on an upbeat note. The private sector adapted to a changing business environment, while powerful offsets came from lower US tariffs than originally announced, some fiscal support, and favorable financial conditions coupled with strong productivity gains and a tech boom. Despite some downside risks, the momentum was expected to carry over into 2026, lifting the pre-conflict global growth forecast to 3.4 percent.

War in the Middle East has halted this momentum. The closing of the Strait of Hormuz and serious damage to critical facilities in a region central to global hydrocarbon supply raise the prospect of a major energy crisis should hostilities continue.

War’s economic impact

The shock’s ultimate magnitude will depend on the conflict’s duration and scale—and how quickly energy production and shipment normalize once hostilities end.

This impact will depend on three channels.

• First, higher commodity prices are a textbook negative supply shock, raising costs for energy‑intensive goods and services, disrupting supply chains, lifting headline inflation, and eroding purchasing power.
• Second, these effects could be amplified as firms and workers try to recoup losses, risking wage‑price spirals, especially where inflation expectations are poorly anchored.
• Third, heightened macro risks and the prospect of tighter monetary policy could trigger a sudden repricing by financial markets—with much lower asset valuations, higher risk premia, more capital flight, and dollar appreciation—tightening financial conditions and dampening aggregate demand.

Our reference forecast, which assumes a short-lived conflict and a moderate 19 percent increase in energy commodities prices in 2026, still puts global growth at only 3.1 percent this year and headline inflation at 4.4 percent, a sharp deviation from the global disinflation trend in recent years.

A longer shutdown of the Strait of Hormuz and further damage to drilling and refining facilities would disrupt the global economy more deeply and for longer. In an adverse scenario, assuming a sharper increase in energy prices this year coupled with rising inflation expectations and some tightening of financial conditions, growth falls to 2.5 percent this year and inflation rises to 5.4 percent.

In a severe scenario where energy supply dislocations extend into next year, inflation expectations become markedly less anchored, and financial conditions tighten sharply, global growth would decline to 2 percent this year and next, while inflation would exceed 6 percent. Despite the recent news of a temporary ceasefire, some damage is already done, and the downside risks remain elevated.

Countries will feel the impact differently. As in past commodity-price surges, importers are highly exposed. Low-income and developing economies—especially those with vulnerabilities and limited buffers—are likely to be hit hardest. Gulf energy exporters will face economic fallout from damaged infrastructure, production disruptions, export constraints, and weaker tourism and business activity. Remittances will fall in countries that supply migrant workers to the region.

Lessons from 2022 crisis

Today’s shock echoes the 2022 commodity price surge following Russia’s invasion of Ukraine, which helped push global inflation to the highest since the 1970s. In that episode, the subsequent synchronized tightening and disinflation without a recession is widely seen as a major policy success.

Can we expect the same outcome now? There are reasons to doubt it. In 2022, inflation pressures were already elevated coming from post‑pandemic supply-demand imbalances, tight labor markets, and abundant liquidity. Today, softer labor markets and normalized balance sheets have eased underlying pressures, though inflation remains above target in some countries, notably the United States. If the shock remains modest, inflation may be more contained, consistent with our reference scenario.

Still, the last episode left scars. Permanently higher price levels have raised cost‑of‑living concerns and made inflation expectations more sensitive to new price increases. Moreover, the 2022 surge reflected an unusually steep aggregate supply curve, with strong demand running into supply bottlenecks, allowing central banks to achieve disinflation with limited output losses. Evidence now suggests a return to a flatter supply curve, making disinflation more costly.

Policies

How should central banks react? Obviously, the best way to limit economic damage is an early and orderly end to the war. Beyond that, central banks can generally look through an energy-price surge but only as long as inflation expectations remain well-anchored. The energy shock already weakens activity while raising prices, and no central bank can influence global energy prices on its own. But if medium- or long-term inflation expectations drift up as prices and wages pick up, restoring price stability must take precedence over near-term growth, with a swift tightening. While exchange rate flexibility allows monetary policy to focus on price stability, foreign exchange interventions or capital flow management measures may be considered in some cases, in line with our Integrated Policy Framework.

What should fiscal policy do? Untargeted measures—price caps, subsidies, and similar interventions—are popular. But they are frequently poorly designed and costly. Given the lack of fiscal space with still elevated budget deficits and rising public debt, any fiscal support should remain narrowly targeted and temporary—with clear sunset clauses, and consistent with medium-term fiscal plans to rebuild buffers. Avoiding fiscal stimulus is also critical when inflation is rising, so as not to complicate central banks’ task.

Preserving price signals is important: high prices signal scarcity, encouraging demand restraint and supply expansion. Price controls and export restrictions cannot change that fact. Worse, such measures often backfire by raising underlying prices, leading to rationing and shifting adverse spillovers to other countries. If needed, direct, targeted transfers to vulnerable households and firms typically provide greater relief at lower fiscal cost than broad subsidies. Too often, this lesson was missed in 2022; countries should do better this time.

Finally, if financial conditions tighten sharply and global activity deteriorates markedly, monetary and fiscal policy should stand ready to pivot to support the economy and safeguard the financial system, alongside appropriate financial and liquidity policies.

Resilience amid challenges 

The latest war underscores that the international order is under growing strain, with fraying alliances, new conflicts, and national-security concerns shaping economic policy. Our analytical chapters examine the macroeconomic effects of defense buildups and draw lessons for economies in conflict or reconstruction. The conclusion is sobering: beyond its human toll, war imposes large, persistent economic costs and difficult trade-offs.

Beyond active conflicts, geopolitical tensions are reshaping an increasingly multipolar world with waves of trade restrictions imposed by all major economic blocs, harming international cooperation and growth. While these shifts may reinforce inward-looking policies, we also see trade being rerouted through new partners and regional agreements that do not necessarily align with old geopolitical boundaries.

The conflict in the Middle East commands immediate attention, but it should not distract from the pursuit of durable growth. Advances in artificial intelligence—especially agentic AI—offer the potential for large productivity gains, the ultimate driver of living standards. Yet the transition may be bumpy: markets may be ahead of fundamentals, risking corrections, and rapid change could displace workers and weigh on demand. Policymakers should promote diffusion and adoption while investing in skills to ease the labor-market transition. The war should also spur faster adoption of renewable energy, which can strengthen resilience to energy shocks, improve energy security, and support the climate transition.

The world economy faces another difficult test. And while it may become more multipolar, it need not become more fragmented. We should keep strengthening global cooperation; with the right policies—including a swift cessation of hostilities and the reopening of the Strait of Hormuz—the damage can remain limited. International financial institutions such as the IMF were born out of a vision, forged in the aftermath of war and great destruction, to advance economic and financial cooperation and integration for the benefit of all. Today, those principles are more vital than ever to preserve global prosperity.