Iran war closure of Strait of Hormuz drives oil to $120, threatening global economy

The Hormuz closure has placed the global economy in what the Peterson Institute’s Maurice Obstfeld called ‘the nightmare scenario’ — a sustained cutoff of the world’s most critical oil transit route at a moment when global inflation remained elevated and household budgets in the United States and elsewhere were already under strain.

The closure of the Strait of Hormuz following U.S. and Israeli missile strikes that killed Iranian Supreme Leader Ayatollah Ali Khamenei on Feb. 28 is delivering compounding damage to the global economy, driving up energy and food prices, threatening developing nations with shortages, and narrowing the options available to central banks including the Federal Reserve, economists said Monday.

“For a long time, the nightmare scenario that deterred the U.S. from even thinking about an attack on Iran and which got them to urge restraint on Israel was that the Iranians would close the Strait of Hormuz,” said Maurice Obstfeld, a senior fellow at the Peterson Institute for International Economics and former chief economist at the International Monetary Fund. “Now we’re in the nightmare scenario.”

Oil surges to $120; U.S. gasoline follows

Oil prices surged from less than $70 a barrel on Feb. 27 to a peak of nearly $120 early Monday before settling closer to $90, the Associated Press reported. The average price of U.S. gasoline has risen to $3.48 a gallon from just under $3 a week ago, according to AAA. Prices are expected to be felt even more severely in Asia and Europe, which are more dependent on Middle Eastern oil and gas than the United States.

The waterway at the center of the crisis carries a disproportionate share of global supply. “The Strait of Hormuz has to be reopened,” said Simon Johnson, an economist at the Massachusetts Institute of Technology and recipient of the 2024 Nobel memorial prize in economics. “It’s 20 million barrels of oil a day going through there. There’s no excess capacity anywhere in the world that can fill that gap.”

IMF Managing Director Kristalina Georgieva said every 10% increase in oil prices — provided it persists for most of the year — will push up global inflation by 0.4 percentage points and reduce worldwide economic output by as much as 0.2%.

Winners and losers across the world economy

Energy-importing countries face the sharpest pressure. Most of Europe, South Korea, Taiwan, Japan, India, and China will be hurt by higher prices, economist Neil Shearing of Capital Economics wrote in a commentary for the Chatham House think tank.

Pakistan faces a particularly difficult position. The South Asian country imports 40% of its energy and relies especially heavily on liquified natural gas from Qatar, supplies of which have been cut off by the conflict, the AP reported. Economists Gareth Leather and Mark Williams of Capital Economics said Pakistan’s central bank will likely have to raise interest rates rather than cut them, because inflation there is already elevated and higher energy prices threaten to make it worse.

Governments across Asia have already begun adjusting. India’s restaurants have warned of possible closures as the government prioritizes gas for households. Thailand has suspended overseas travel for civil servants and urged them to take stairs instead of elevators. The Philippines has introduced a temporary four-day workweek for some government agencies. Vietnam is encouraging people to work from home.

Oil-producing countries outside the conflict zone — Norway, Russia, Canada — are expected to benefit from elevated prices without the risk of missile and drone attacks, Shearing wrote.

Fertilizer shipments cut; food shortages feared

The Strait’s closure has also severed fertilizer shipments. Up to 30% of world fertilizer exports — including urea, ammonia, phosphates, and sulfur — pass through the waterway, according to Joseph Glauber of the International Food Policy Research Institute.

“Any countries with significant agriculture sectors, including the United States, would be vulnerable,” Obstfeld said. “The effects are going to be most devastating in low-income countries where agricultural productivity may already be challenged. Add this extra cost component and you get the prospect of significant food shortages.”

U.S. households face a $10-a-week squeeze

The United States, now a net exporter of energy, is expected to gain slightly overall from higher oil and gas prices. But ordinary American families will feel the costs at a time when household budgets were already under pressure ahead of November’s midterm elections.

U.S. households spend about $2,500 a year — nearly $50 a week — on gasoline, said Mark Mathews, chief economist at the National Retail Federation. A 20% increase in gasoline prices means roughly $10 extra per week. “If I have to pay more for an essential, then I would reduce a discretionary item,” Mathews said.

Analysts at Evercore ISI calculated that if oil prices remain around $100 a barrel, the resulting increase in gasoline costs will wipe out for most Americans the benefits of higher tax refunds from Trump’s 2025 tax cuts. Only the top 30% of earners would still see a net gain, they said.

Central banks face a bind

The conflict has put central banks in a difficult position. Higher energy prices feed inflation but also weigh on economic output — forcing policymakers to choose between competing pressures.

At the Federal Reserve, the dilemma is particularly sharp. Core PCE inflation — the Fed’s preferred gauge, which excludes food and energy — was running at approximately 3.0% year-over-year as of March 10, above the central bank’s 2% target, according to data from the Federal Reserve Bank of St. Louis. The war’s energy shock adds fresh upward pressure on an economy where inflation had already proved difficult to bring fully to target.

Johnson said central bankers would likely draw on a historical parallel. “Their minds will easily go to the 1970s,” he said, when conflict in the Middle East and an Arab oil embargo sent oil prices surging. His predecessors at the time “thought it was a temporary shock. They thought they could accommodate with lower interest rates, and they ended up regretting that because inflation became much higher,” he said.

Johnson predicted that higher energy prices from the Iran war are “going to massively intensify the debate inside the Fed” and make U.S. rate cuts less likely.

Duration and U.S. objectives remain unclear

The length of the crisis is uncertain, and so is what the United States is trying to achieve.

“The question is how long is it going to go on?” Johnson said. Iran’s new leader, Mojtaba Khamanei — son of the slain ayatollah — is believed to be an even more committed hardliner than his father, according to the AP.

“This is all about President Trump,” Johnson said. “It’s not clear when he’s going to declare victory.”

Some economists expressed cautious optimism that the global economy could manage. “The world economy has shown itself capable of shaking off significant shocks like broad U.S. tariffs, so there is room for optimism that it will prove resilient to the fallout of the war on Iran,” said Eswar Prasad, professor of trade policy at Cornell University.

Especially if oil prices retreat to the $70-to-$80-a-barrel range, Shearing wrote, “the world economy may absorb the shock with less disruption than many fear.”