Middle East looms as global economic threat but a bigger risk is closer to home

In today’s globalised financial system, no segment of the economy is an island.

The harrowing events unfolding in Israel and Palestine have pushed Ukraine from the front pages.

The impact of the Russian invasion of Ukraine on Australia’s housing and construction sectors were pronounced, with the cost of building materials soaring as supply chains were disrupted, energy price globally shot up and raw materials became scarcer.

Market observers are now turning their eyes to the Middle East and assessing the potential economic fallout that conflict may deliver.

There is, however, another global player that isn’t attracting the attention yet has significant implications for Australia’s economy and housing market. But more on that in a moment.

While Israel, Lebanon and Syria are not big oil producers, the prospect of Iran being drawn into the conflict in a proxy battle with the United States cannot be dismissed. The US has not parked two aircraft carriers and around 150 fighter jets in the eastern Mediterranean on a sight-seeing excursion.

Should that worst case humanitarian and geopolitical scenario unfold and the wider Middle East is drawn into a protracted conflict, the implications will echo through global economies, including Australia’s.

Inflation through high oil prices is the primary concern for Australia’s economy.  

Higher inflation equates to higher interest rates, possibly suppressing property prices as a result.

Since Hamas’ attacks the global economy has been largely unmoved. Oil is up marginally but within normal trading volatility. The Australian dollar, which usually retreats in times of market uncertainty is largely unmoved.

What will move the dial and have global economic repercussions is if oil supplies from major producers in the Middle East are impacted.

If Iran, which backs Hamas in Palestine and Hezbollah in Lebanon, is drawn deeper into the war it could threaten its oil production (2.5 per cent of global consumption), the flow of oil through the Strait of Hormuz (through which 20 per cent of world oil flows) or even Saudi Arabian production.

RBA needs restraint on inflation fight

If oil prices soar, it makes it harder for central banks around the world to sit on their hands with interest rates as they are forced to tackle another bout of inflationary pressure.

Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist, AMP Investments, on Tuesday (17 October) said the rise in petrol prices since May has increased the typical Australian household’s weekly car fuel bill by about $12.

“With household budgets now stretched and the reopening boost behind us this likely means that $12 a week less is available for spending elsewhere, which in turn will likely reduce underlying inflation pressures and add to the risk of recession.”

The Reserve Bank of Australia (RBA), he said, should not take the bait if the Israel-Gaza troubles broaden in scope.

“Overall, we would see any further surge in oil and petrol prices that may flow from events in the Middle East as being a further dampener on economic growth and underlying inflation.

“As such, the RBA should look through it rather than further increase interest rates.”

Where might the bigger economic hit come from?

While we may think of Australia as a global economic minnow, its property market is the tenth largest in the world in terms of value.

Sitting at the top of the property pile is Australia’s largest trading partner.

China made up just over a quarter (26 per cent) of the world’s real estate value as of 2022, according to recently released data from Savills World Research. This comprises both residential and commercial real estate.

That compares to the United States of America that accounted for 19 per cent of the total global real estate value.

When the US housing market collapsed in 2008, it precipitated a global economic meltdown that became known as the GFC (global financial crisis).

Today, China’s property market is teetering on the brink and its largest developers, holding the highest debt levels of any corporations in the world, are close to collapse.

Should that happen, there is the very real risk of the contagion impacting Australia.

Certainly, the RBA thinks it’s an issue worth keeping an eye on.

In the Minutes of the Monetary Policy Meeting of the Reserve Bank Board released Tuesday, there were ten mentions of China and no references to the Ukraine or Middle East conflicts.

It noted that a Chinese slowdown could present risks to Australia.

“In China, the most recent indicators of economic activity had been somewhat more positive than in prior months (but) members observed that the property market remained the key exception; real estate investment, new housing starts and housing prices had all declined further over the preceding month.

“In response, Chinese authorities had implemented further modest policy stimulus measures targeted at the property and household sectors as well as infrastructure investment.

“A material slowdown in the Chinese economy remained a key risk to the global outlook,” the Minutes noted.

Unlike the US, China’s debt is mostly held domestically, somewhat limiting the prospects of a property market collapse there causing another GFC.

“In view of the limited extent of China’s direct financial linkages with Australia and other advanced economies, members noted that the effects of financial stress in China – were they to materialise – would be felt mostly via trade linkages and an increase in risk aversion in global financial markets,” the RBA Board noted.

It also said that its decision to hold rates steady this month was due in part to the challenges in the Chinese economy potentially leading to slower growth in Australia if not contained. 

While the economic impact of a Chinese slowdown could ultimately weigh on property prices as export income falls, there was also a potential upside.

Australia is experiencing its strongest population growth in decades, and a faltering Chinese property market could drive more Chinese nationals to invest in Australian real estate.

That could in turn lead to further inflation and complicate the RBA’s decision-making process around interest rates.

For now, Australia can only sit on the sidelines and watch as global events play out that may or may not have huge implications for Australia’s economy and ultimately its housing market.