The Economic Consequences Of The Gaza War Can Be Deceptive

Financial markets have often mis-priced major geopolitical shocks and they may have got their probabilities wrong again

- NOURIEL ROUBINI

In the first scenario, the war remains mostly confined to Gaza, with no regional escalation beyond the small-scale skirmishes with Iranian proxies in countries next to Israel; indeed, most players now prefer to avoid a regional escalation. The Israel Defense Forces’ Gaza campaign significantly erodes Hamas, leaving a high civilian casualty toll, and the unstable geopolitical status quo survives. Having lost support, Israeli Prime Minister Binyamin Netanyahu leaves office, but Israeli public sentiment remains hardened against accepting a two-state solution. So the Palestinian issue festers; normalization of diplomatic relations with Saudi Arabia is frozen; Iran remains a destabilizing force in the region; and the US continues to worry about the next flare-up.

The economic and market implications of this scenario are mild. The current modest rise in oil prices would recede, because there will have been no shock to regional production and exports from the Gulf. Though the US could try to interdict Iranian oil exports to punish it for its destabilizing role, it is unlikely to pursue such an escalatory measure. Iran’s economy would continue to stagnate under existing sanctions, deepening its dependence on ties with China and Russia. Meanwhile, Israel would suffer a serious but manageable recession, and Europe would experience some negative effects as modestly higher oil prices and war-driven uncertainties affect business and household confidence. This scenario, by reducing output, spending and employment, could tip stagnant European economies into mild recessions.