Middle East Tensions: What Australia's Markets Need to Watch Amid Inflation Risks

The escalating geopolitical landscape in the Middle East, particularly between Israel and Iran, is sending ripples across global financial markets, and Australia is certainly feeling the tremors. With the specter of disrupted oil supplies looming large, the unwelcome prospect of reignited inflation is forcing investors to recalibrate their strategies.

From the shimmering allure of gold to the daily grind of petrol prices, and from the intricate dance of interest rates to the rollercoaster of share markets, a palpable sense of unease is prompting a shift in investment priorities. Australians, in particular, are keen to understand how these distant tensions could hit closer to home.

Here's a closer look at four key market movements Australians should be keeping a watchful eye on:

1. The Pump Pain: Rising Petrol Prices

The past few weeks have seen a noticeable climb in oil prices, surging from approximately US$62 to US$74 a barrel. This upward trend unfortunately reverses a period of relief for household budgets, where falling fuel costs had helped ease the sting of living expenses.

According to Shane Oliver, Chief Economist at AMP, Australian motorists could soon face an additional 12 cents per litre at the petrol pump if these elevated oil prices persist. While the intricate mechanics of fuel pricing involve numerous factors, including those seemingly defying typical supply and demand cycles, Oliver offers a simple rule of thumb: a US$1 change in the international price of a barrel of oil generally translates to a 1 cent increase or decrease at our local bowser.

It typically takes a couple of weeks for wholesale fuel costs to trickle down to the prices we see at service stations. Some analysts even suggest that oil prices could breach the US$80 mark if the Middle East situation further deteriorates. A critical focal point for oil traders remains the Strait of Hormuz, a narrow yet vital choke point for global oil shipments that Iran has previously, in times of heightened tension, threatened to close.

2. Interest Rate Jitters: A Delicate Balance

The surge in oil prices presents a particular headache for central banks globally, and notably, for the narrative surrounding potential interest rate cuts. For instance, in the United States, any significant rise in petrol prices, combined with increased consumer costs due to tariffs, could fuel another inflationary spike, potentially making interest rate reductions less likely.

However, the impact of oil prices on Australia's inflation outlook is anticipated to be somewhat less dramatic. Shane Oliver doesn't foresee it triggering a major inflationary shock that would derail the Reserve Bank of Australia's (RBA) anticipated trajectory of rate cuts. Indeed, financial markets haven't significantly altered their bets on RBA rate movements, still pricing in three more cuts this year, with the first potentially arriving at the next meeting in about three weeks.

Jacob Falkencrone, Global Head of Investment Strategy at Saxo, outlines three plausible scenarios stemming from the Middle East conflict, each with distinct implications for interest rates:

Contained Conflict: The conflict remains limited, and energy prices quickly moderate, easing inflationary pressures.

Diplomatic Breakthrough: A swift diplomatic resolution emerges, leading to a "relief rally" in markets and potentially an even faster fall in oil prices.

Regional War: A broader regional conflict erupts, causing oil prices to surge and compelling central banks to reconsider their rate cut outlook as inflation builds.

3. The Luster of Gold: A Safe Haven's Appeal

Gold prices have recently reached unprecedented highs, with its traditional status as a "safe haven" asset attracting immense interest from traders seeking refuge amidst economic and geopolitical turbulence. While the Middle East conflict has propelled the precious metal towards US$3,500 an ounce, its ascent was already well underway before the recent Israeli strikes against Iran.

In recent months, gold has increasingly been viewed as a dependable store of value, especially as confidence in the US dollar – another historical safe haven – appears to be waning. This trend aligns with the "sell America" trade, where investors are shifting capital out of various US assets, partly in response to new tariff regimes. This sentiment has also sparked interest in Bitcoin, sometimes dubbed "digital gold" and popular among younger investors.

Chris Weston, Head of Research at Pepperstone, highlights that the investment case for gold is currently seen as remarkably clear-cut by the market.

While the Australian dollar, often considered a proxy for risk appetite, initially dipped against the US dollar following the Israeli strikes, these declines have been relatively contained. Its future trajectory is now closely linked to whether the Middle East conflict escalates or de-escalates. The local currency has, in fact, benefited from the broader "sell America" sentiment, which has so far helped limit its falls against its US counterpart.

4. Share Market Swings: Riding the Volatility Wave

Global share markets, including Australia's ASX, have experienced considerable volatility in recent months, and the current Middle East tensions are adding to the choppy waters. Share price movements have been mixed in the days following the initial Israeli strikes.

On the upside, gold stocks have seen gains, as have shares in oil and gas giants like Woodside. Other energy companies, such as uranium producer Paladin, are also surging, driven by concerns over global energy supplies. Notably, increases in commodity prices often translate into a larger tax take for Australia, providing a welcome boost to the federal budget.

Conversely, global travel and airline stocks, including major players like Qantas and Flight Centre, have seen declines. Investors are worried about a potential slowdown in bookings due to the hostilities, and the impact of rising fuel prices on airline profitability is also a significant concern.

AMP cautions that the "share market ride is likely to remain volatile in the near term," urging investors to brace for continued fluctuations.