This is how Trump breaking the Iran nuclear deal will hit the global economy

Knife display at Daiso in SingaporeKnife display at Daiso in Singapore

The unilateral decision by the U.S. to violate the multi-lateral pact with Iran could have far-reaching implications for the global economy, analysts said.

U.S. President Trump on Tuesday announced that he would pull out of the international deal with Iran; the pact had limited Iran’s nuclear program and allowed inspections in exchange for the easing of economic sanctions on the country. Trump said that sanctions would be reimposed.

Perhaps the most immediate impact was likely to be higher oil prices.

Gregory Daco, head of U.S. economics at Oxford Economics, said in a note on Tuesday that Iran, the world’s fifth largest oil producer, would likely “gradually and modestly” lower its production.

”In an environment of increased global supply tightness, this will put further upward pressure on oil prices,” he said.

Nymex WTI futures were up 0.13 percent at US$71.23 at 7:21 A.M. SGT on Thursday, while ICE Brent futures were up 3.15 percent at US$77.21 at 5:58 A.M. SGT, according to Bloomberg data.

Pocketbook hit

Daco attributed WTI’s recent rise above US$70 a barrel, its highest since 2014, in part to anticipation that Trump would violate the Iran pact. The higher price was likely to hit the U.S. economy.

If WTI averages over US$70 a barrel this year, that will drag the U.S. economy this year by around half the expected 0.7 percentage point fiscal stimulus boost from tax cuts and the budget, he said.

Additionally, “if sustained, rising oil prices could sap global momentum,” he said, noting oil importing countries will face higher input and production costs, limiting business activity and boosting inflation. “Simultaneously, higher prices at the pump and elevated inflation constrains households’ disposable income and outlays.”

The impact on U.S. consumers may be deepened by the Trump administration’s move to scrap Obama-era fuel-efficiency requirements for cars as well as the popularity of SUVs, which are less fuel efficient. Fewer smaller cars are set to be available for U.S. consumers as Ford is discontinuing most of its passenger car lineup.

Why U.S. shale won’t help much

Other analysts noted that hopes the U.S. shale oil production would help to offset the pain of Iran output cuts were misplaced.

Greg Sharenow and Tiffany Wilding, a portfolio manager and an economist, respectively, at Pimco, said in a blog post earlier this week that the decline in the U.S. oil trade deficit over the past five to 10 years would help mitigate some of the pain in higher oil prices. But they added, “on net, rising oil prices will likely act like a regressive tax on consumption.

The also cautioned against expecting too much from any increased energy investments in the U.S.

”Shortages in skilled labor and drilling and pressure-pump equipment, as well as diminished pipeline capacity in key producing basins, will limit U.S. oil producters’ ability to ramp up capital spending,” they said.

Additionally, “the Trump administration’s potential tariffs on steel and aluminium, key inputs into energy drilling equipment, could also reduce the economic value of additional investment,” they said.

Oil importers face hit

DBS Chief Economist Taimur Baig said in a note on Wednesday that the return of Iran sanctions would cause “substantial upside risk” to spot oil prices, which in turn would likely dent the current account and fiscal positions of oil-importing economies.

“Coming at a time when emerging markets are already under pressure in the rates and foreign-exchange space, this could tip some oil importers into distress in the second half of this year,” Baig said.

Baig also pointed to the risks to the Middle East, saying the risk of conflict was set to escalate as it became clear the U.S. had an ultimate goal of regime change in Iran.

“Given Iran’s footprints in Iraq, Syria, Lebanon, and Yemen, an existential threat to Iran’s present regime will readily spill over into a major regional conflict, in our view,” Baig said. “We are concerned that the coming months could see widening skirmishes in the region.”