The war in the Middle East is upending lives and livelihoods in the region and beyond, dimming the outlook for many economies recovering from previous crises. Uncertainty around inflation, interest rates, and the economy is driving many investors back to the dollar, turning earlier expectations upside down. This shift follows a period in 2025 when expectations of lowered U.S. interest rates and concerns over U.S. creditworthiness significantly weakened the dollar, while the Swedish krona became one of the year's big currency winners due to general optimism around the Swedish economy. Since the year's bottom at 8.77 at the end of January, the exchange rate has turned to 9.45 – the strongest level since December 2025.
Energy is the main transmission channel for the economic impact, with the de facto closure of the Strait of Hormuz and damage to regional infrastructure causing the largest disruption to the global oil market in history, according to the International Energy Agency. Energy shipments from the Middle East have been at a standstill following Iran's threats to attack vessels in the critical trade waterway as retaliation against U.S.-Israeli strikes. Oil prices have at points soared to close to $120 (£90) a barrel due to strikes on shipping and energy infrastructure and the effective closure of the strait. About 25 to 30 percent of global oil and 20 percent of liquefied natural gas pass through the Strait of Hormuz, feeding demand in Asia and parts of Europe.
The shock from the Middle East conflict is global but asymmetric, with energy importers, poorer countries, and those with meager buffers more exposed than exporters, richer ones, and those with ample reserves. Large energy importers in Asia and Europe are bearing the brunt of higher fuel and input costs due to disruptions in the Strait of Hormuz. Economies heavily dependent on oil imports in Africa and Asia are finding it increasingly hard to access supplies, even at inflated prices. Low-income countries are especially at risk of food insecurity and may need more external support, which has been declining.
Central banks kept interest rates unchanged this week, as expected, highlighting the severity of the Middle East conflict which has caused oil prices to surge. The Bank of England's Monetary Policy Committee unanimously voted to keep the rate unchanged at 3.75 percent, based on uncertainty over the conflict's length and potential impact on energy prices. The European Central Bank kept rates at 2 percent, with a hold long expected. The decisions by central banks signal that uncertainty and inflation risks have risen, mainly due to the oil-driven energy shock.
The blockade has led to a global oil shortage, rocking Gulf-reliant Asian countries hard, with the Philippines mandating four-day work weeks to save fuel and Indonesia seeking ways to avoid burning through reserves lasting just weeks. China, the world's largest buyer of oil, is feeling strain but sits in a better position than neighbours due to years of statecraft preparing for a global energy crisis. China uses an estimated 15 to 16 million barrels of oil daily, mainly for transportation, with much coming from abroad, according to market analysts. Gulf countries are a major source of oil for China, with Saudi Arabia and Iran accounting for over 10% of imports each, according to the U.S. Energy Information Administration.
China's north is mainly powered by domestically produced oil and pipeline imports from Russia, which are not disrupted by the Middle East war. Russian oil accounts for nearly a fifth of China's energy imports, making Moscow its biggest oil supplier despite sanctions. Coal is the dominant source of power for most of China's electricity, with China as the world's largest coal producer, accounting for over half of global production. Oil and gas account for just over a quarter of China's total energy consumption.
Despite the dollar recently performing its best quarter since the end of 2024, structural question marks remain. The IMF's latest data shows a gradual reduction in the dollar's share in the world's central bank reserves, with the euro and yuan seen as the main challengers. Analysts warn, according to Lifefinance, that the dollar still faces downward pressure in the long term.
Currency markets are weighing different scenarios. If hopes for de-escalation in the Middle East are realized, the U.S. currency is expected to lose quickly. In such a scenario, yesterday's losers, such as the euro, the krona, and stocks, could again become winners while the dollar and oil prices fall, according to Reuters. Markets are beginning to factor in a prolonged conflict scenario like Ukraine, but rumors of negotiations have prompted investors to gravitate toward a short conflict scenario, with EUR/USD posting its best daily rally in a month. If the Middle East conflict ends quickly like in 2025, the EUR/USD pair may quickly recover losses; if it drags on like in Ukraine, the U.S. dollar will gain.
A prolonged conflict scenario implies continued rally in oil prices, accelerated global inflation, and slowed economic growth, similar to 2022, with the USD index rising by 6% from the start of the Ukraine conflict to year-end. Prolonged escalation could cause energy price spikes to spill over into core economic indicators like inflation, interest rates, trade balances, and GDP growth, derailing fiscal and monetary goals.
The U.S. economic outlook remains a factor. Vanguard expects the worst-case scenario, with the Fed easing monetary policy only once, due to a stable U.S. labor market and economy capable of accelerating under tax cuts. ADP's February private sector employment growth of 63,000, the best since July, confirms Vanguard's view of a strong U.S. economy. The Supreme Court demanding the U.S. government return $130 billion in tariffs is positive for the U.S. economy, acting like a new fiscal stimulus. Higher-than-expected growth in the U.S. services sector in February evidences the U.S. economy is in good shape.
Continued war does not automatically strengthen the dollar, with another risk emerging in the east where Japan's currency has lost footing quickly. The situation threatens carry-trades between Japan's yen and the U.S. dollar. If the Japanese are forced to support-buy their currency, it could lead to pressure on the U.S. currency, similar to what was seen in 2024. Then the crash could become a fact due to the economic pressure the war in Iran entails for Japan.
Stress is emerging in private credit markets. Blue Owl Capital, one of the largest players in private credit, has lost 40 percent of its market value this year after investors have requested withdrawals from the company's funds at an increasingly rapid pace. The company revealed on Thursday that withdrawal requests shot up during the latest quarter.
The Swedish krona's recent strength contrasts with the dollar's earlier 2025 decline. Expectations of lowered interest rates in the U.S. and concerns over U.S. creditworthiness and economic strength significantly lowered the dollar during 2025. The Swedish krona became one of the year's big currency winners due to general optimism around the Swedish economy. Since the year's bottom at 8.77 at the end of January, the exchange rate has turned to 9.45 – the strongest level since December 2025.
Key unknowns persist. The duration of the conflict, extent of disruptions in the Strait of Hormuz, and outages at key energy infrastructure in the Persian Gulf remain key unknowns. Iran is negotiating with Oman to open the strait that restricts the world's access to important resources, but the success and timing of these talks are unclear. If the conflict in Iran ends, it is likely that the valuation will fall and other asset classes that were strong before the war regain some of their advantage. Markets anticipate two rounds of monetary expansion by the Federal Reserve by end of 2026, shifting expectations from June to July, implying the conflict will be resolved, but how central banks will adjust if the conflict prolongs remains uncertain.
The war has caused serious disruption to the economies of the most directly affected countries, including damage to infrastructure and industries that could become long-lasting, negatively affecting their short-term growth prospects. For fuel-importing economies, the effect of the energy disruption is like a large, sudden tax on income. Parts of the Middle East, Africa, Asia-Pacific, and Latin America face higher food and fertilizer prices and tighter financial conditions due to the conflict.
Remaining uncertainties include oil transit estimates and energy market vulnerabilities. Energy prices, supply chains, and financial markets are the main transmission channels for the economic impact of the Middle East conflict, with regional effects varying significantly. Energy-importing economies in Africa, the Middle East, and Latin America are feeling strain from higher import bills on top of limited fiscal space. Prolonged escalation could cause energy price spikes to spill over into core economic indicators like inflation, interest rates, trade balances, and GDP growth, derailing fiscal and monetary goals.