Prolonged Middle East conflict could strain developed economies, Fitch warns

A prolonged conflict in the Middle East could create new credit challenges for developed market sovereigns in Europe and Asia, driven by higher energy costs, inflation and weaker economic growth, Fitch Ratings said.

The agency said the main risks would come through rising oil and gas prices, tighter financing conditions and increased fiscal pressure as governments respond to protect households and businesses.

Sovereigns with higher debt levels, structural deficits and more difficult inflation-growth trade-offs would be more vulnerable to a sustained shock, Fitch said.

Energy prices and growth risks

Fitch said higher energy prices would be the most direct channel of impact, feeding into inflation and reducing real incomes and domestic demand.

Its baseline assumes Brent crude prices remain near current levels before easing to an average of $70 per barrel in 2026.

However, under an alternative scenario where oil prices rise to $95 to $100 per barrel throughout 2026, economic growth across developed markets would slow, potentially pushing some countries close to recession.

“Our simulation suggests that inflation risks are most acute in Italy, the UK, Japan and France,” Fitch said, citing their energy supply structures.

The impact on economic growth would be most pronounced in South Korea, Japan, the UK and Italy, where higher energy and transport costs could significantly reduce household consumption.

Among smaller developed markets, the effects would vary more widely, with central and eastern European economies, including the Baltic states and Slovenia, as well as Taiwan, facing stronger growth impacts.

Norway stands out as an exception due to its status as an energy exporter, which could benefit from higher oil prices, Fitch said.

Fiscal and financing pressures

Fitch said governments are likely to respond with fiscal measures to cushion the impact of higher energy costs.

Such measures could include price caps, tax rebates and direct support for households and energy-intensive sectors.

In the event of a prolonged shock, the European Commission could ease fiscal rules to allow higher spending, potentially through a general escape clause or coordinated support mechanisms at the EU level.

However, the cost of these measures could increase budget deficits and debt levels at a time when many developed economies are already facing higher borrowing costs.

“We would expect any fiscal support measures to be more narrowly targeted than during the 2022-2023 energy price spike,” Fitch said.

Borrowing costs and policy outlook

Eurozone government bond yield spreads have already risen by an average of 29 basis points since Feb. 27, reflecting tighter financing conditions.

If higher borrowing costs persist, they could increase medium-term fiscal pressures as governments refinance debt at higher interest rates, Fitch said.

The agency added that while these dynamics are unlikely to create immediate fiscal crises, they could limit policy flexibility if growth weakens further.

Monetary policy responses will depend on how central banks balance rising inflation with slowing economic activity.

Under a high oil price scenario, central banks may be constrained in raising interest rates, as tighter policy could further weaken demand and employment.

Fitch said rate paths are therefore unlikely to diverge significantly from current expectations despite elevated inflation risks.