SEB Nordic Outlook: Growth prospects are exposed to the impact of the Iran war and rising energy prices
Risks to the global economy are increasing as energy prices continue to rise due to the ongoing conflict in the Middle East. Thus, the longer the Strait of Hormuz remains closed, the more negative the impact on the economy becomes. Although inflation is increasing, the effects on core inflation and economic growth remain uncertain. Growth is being supported by rising investment in artificial intelligence, defence, and the energy transition, as well as by resilient labour markets and strong risk appetite. Limited fiscal space implies targeted and temporary energy price support measures.
High energy prices constrain growth
In the short term, rising energy prices will significantly increase inflation; however, there is a risk that the negative impact could become persistent. The direct impact, i..e, higher fuel costs, is already evident, and indicators such as the Purchasing Managers’ Index (PMI) point to rising prices and worsening supply conditions. This supports that growth is slowing, shifting from the relatively strong starting point seen at the beginning of this year toward a situation where stagflation risks are emerging. Businesses, households, and financial markets have demonstrated impressive adaptability, and we expect this resilience to continue under our baseline scenario. Investment in areas such as artificial intelligence, the energy transition, and security policy, together with somewhat more predictable US trade policy, is helping to support global growth. Nevertheless, the current energy crisis is severe, and its consequences will persist for a long time, even after a peace agreement is reached in the Middle East. The main uncertainties relate to the duration of the Strait’s closure, the extent of damage to energy infrastructure, and the impact on global supply chains.
The main scenario outlined in Nordic Outlook leads us to downgrade our global growth forecast. Although the increase in oil prices over the past week is concerning, it is worth remembering that prices can decline rapidly. It will take time for energy flows and other factors to normalise, resulting in higher costs and a deterioration in growth prospects. Some regions, such as Asia and Europe, are relatively more affected than, for example, the United States. The crisis reinforces the need for strategic autonomy and energy security, while simultaneously accelerating the reduction of dependence on fossil fuels, particularly in energy resource-importing countries.
Economic Growth: 0.8% in the Eurozone, 2.1% in the US, and 4.7% in China
The slowdown in US growth is modest, partly because, in the absence of the energy crisis, the growth forecast would have been revised upward. The key development drivers are investment in artificial intelligence, deregulation, productivity gains, and fiscal policy. The US economy is expected to grow by 2.1% this year. The Eurozone, which is highly dependent on imported energy and has only just recovered from previous energy and trade disruptions, once again faces risks to growth. Growth in the region is expected to reach only 0.8% this year. Nevertheless, support is being provided by a resilient labour market and wage growth, as well as by investment in defence and the broader economy. China’s shift toward more pragmatic and credible growth targets is helping to manage the slowdown and provides policymakers with room to manoeuvre in restructuring the economy, with growth expected to reach 4.7% this year.
In the short term, if energy prices stabilise and decline, their impact on inflation will not be great. The longer-term risk is that higher energy prices begin to spill over into other areas of the economy. However, the impact is expected to be more limited than in 2021–2022. So far, global value chains have not shown the level of stress seen during the pandemic and at the beginning of the war in Ukraine. Nevertheless, everything depends on how quickly the Strait of Hormuz reopens. Many households are expected to respond by restraining consumption. Cautious consumers, with heightened sensitivity to prices following the most recent inflation shock, are likely to make it more difficult for companies to raise prices. So far, inflation data mainly reflect increases in energy prices and the prices of energy-intensive goods. Risks are also emerging for higher food prices, driven by rising fertiliser and fuel costs. Some freight transport prices have started to increase, although they have not yet reached alarming levels. Since energy is embedded, directly or indirectly, in most goods and services, there is a broader risk of rising inflation. If clear shortages of energy or other raw materials emerge, the situation will vary across countries. Further damage to energy infrastructure would increase these risks.
Central banks remain cautious, while stock market risk appetite remains high
Monetary policy is operating in a challenging environment due to the uncertain impact on inflation and growth. If the inflationary effects remain largely direct and do not generate significant secondary effects, central banks may be able to wait and tolerate a temporary period of elevated inflation. Since the outbreak of the war in the Middle East, markets have shifted to pricing in interest rate increases rather than cuts by most central banks. At the same time, the US dollar has strengthened. To some extent, tighter financial conditions mean that markets are doing part of the central banks’ work for them. Our forecast assumes that most central banks will wait for incoming data and avoid making hasty decisions. The Fed is expected to postpone rate cuts until December of this year, but the ECB is expected to implement a precautionary rate increase in June and thereafter keep its policy rate unchanged at 2.25%.
Notwithstanding the seriousness of the situation, risk appetite has remained surprisingly strong. Equity markets reached new highs, while credit risk spreads narrowed. This supports growth, but also creates risks. If the war proves to be more prolonged than currently assumed, weaker risk appetite could trigger a significant correction in asset prices, negatively affecting growth. The longer the Strait of Hormuz remains closed, the greater the negative impact on the global economy will be. A more prolonged conflict increases the risk that inflation will spread from energy prices to other prices, including wages. Higher prices and shortages of certain raw materials, combined with higher policy interest rates and falling asset prices, could sharply slow economic growth. Conversely, a resolution of the conflict in the near future could improve household and business sentiment and stimulate growth. However, the upside potential of such a scenario is limited. In this outlook, we assume that the intensity of the conflict will ease by the summer and that the Strait will reopen. Nevertheless, current indications suggest that the conflict could become protracted.
Oil product inventories are unevenly distributed across regions, resulting in diverging impacts
The increase in Brent crude oil prices is being constrained by high (although declining) inventory levels, the ability to redirect supplies, and partial supply compensation from other producers. High prices have also reduced demand. However, the current disruptions cannot continue indefinitely. Since oil and petroleum product inventories are unevenly distributed across regions, a fragmented picture is emerging in terms of pricing and shortages. For example, the prices of several refined products, particularly jet fuel, have risen sharply. The same applies to diesel fuel. Natural gas prices in Europe are currently not exceptionally high, as the United States has increased its exports and warmer weather has reduced demand. Even once energy supplies normalise, it will take time for the region to restart production of oil, gas, aluminium, and fertilisers. Restoring oil logistics could take up to six months. It should also be noted that liquefied natural gas (LNG) export infrastructure has been damaged. According to some reports, rebuilding this infrastructure could take several years. As a result, energy prices are expected to remain elevated throughout the forecast period. In the long term, the conflict in the Middle East is expected to reduce demand, as energy-importing countries are reminded that domestic energy sources (solar power, wind power, hydropower, nuclear energy, and battery storage) can be both safer and cheaper.
The fiscal response to the energy crisis has so far been relatively limited. In accordance with IMF recommendations, measures should be temporary and targeted. This applies to lower energy taxes and incentives aimed at reducing energy consumption, which are somewhat contradictory measures.
The main drivers of economic growth in the Baltics are investment and domestic demand
Despite increasing uncertainty, adjustments to Latvia’s economic forecasts remain relatively small. Investment will continue to be the main driver of growth, further reinforced by the positive effects of strong construction activity on other sectors. Rapid growth in corporate lending, together with the recovery in household borrowing, is providing additional support to investment and domestic demand, although credit dynamics will remain sensitive to changes in interest rates. Consumption growth will become somewhat stronger, supported by improved labour market conditions and a slight improvement in consumer sentiment, although it will continue to be affected by inflation developments. At the same time, exports will face the effects of weak demand, particularly in key markets. Growth in manufacturing is likely to be significantly more modest than in the previous year. Rising energy prices are once again increasing inflation and creating additional cost pressures across the economy, especially in the energy and food segments, while also affecting other sectors. Unemployment is expected to decline gradually, while wage growth will become more moderate. Latvia’s economy is projected to grow by 2.2% this year.
Lithuania’s economy is expected to grow faster this year, by 3.2%. Pension fund payouts are offsetting the negative impact of rising energy prices. Although wage growth is slowing, purchasing power will continue to improve. Investment growth will continue, while export growth will weaken due to softer global demand. Meanwhile, in Estonia, although inflation is rising again, consumption is being supported by real wage growth, declining unemployment, and tax cuts. However, consumer sentiment remains uncertain. In 2026, growth of approximately 2.5% is expected, driven primarily by domestic demand.
Dainis Gašpuitis
Economist at SEB Bank
