IMF watching for risk that Israel-Hamas war pushes inflation higher

The International Monetary Fund warned of downside risks to worldwide economic growth, including a slowdown in China, climate change, and the potential that the Israel-Hamas war could put upward pressure on inflation.

"Growth is still quite slow and uneven and the risks to this outlook are still very much on the downside," Petya Koeva Brooks, deputy director of the IMF’s research department, told Yahoo Finance.

In its newly released outlook Tuesday, the IMF forecast the global economy will grow at 3% this year, in line with its forecast from July, but downgraded the outlook next year by a tenth of a percentage point to 2.9%.

Brooks says the IMF is closely watching the Israel-Hamas war for any impact on global headline inflation, though she says it’s too early to determine the economic impact of the conflict. While global inflation has peaked on a headline basis — that includes volatile energy and food prices — a spike in global oil prices in response to the Israel-Hamas war threatens to reignite headline inflation if the rise in prices persists.

The risk is the jump in oil prices could seep into so-called core inflation, a measure that removes energy and food prices that central banks use to set interest rates, prolonging the fight against inflation.

Brooks noted that the rule of thumb for how oil prices impact inflation is that a 10% rise in oil prices that's sustained would translate into inflation at the global level of 0.4.

Compounding the risk for headline inflation, Brooks says, is that climate change has now become a macroeconomic issue.

"It's really staggering in how many cases we've downgraded our forecast because of floods or droughts or, again, weather-related events," she said. "This is a particular risk when it comes to food prices and food security. At this stage of the inflation cycle, it's certainly not going to be helpful to have another round of increases in these prices."

Another major risk the IMF sees to the global economy is China’s slowdown, as that country deals with a property sector crisis. The IMF lowered its forecast for the world’s second-largest economy by 0.2% this year to 5% and by 0.3% next year to 4.2%.

China's property giant Evergrande is abandoning its debt restructuring of $19 billion of its international bonds. Another property lender, Country Garden, defaulted on an international payment and also said it doesn’t expect to meet all its US dollar-denominated bond payments or other offshore debt obligations when they come due.

"The question is to what extent the [real estate crisis] would have broader implications," she said.

Brooks says the IMF believes Chinese authorities have the necessary tools to handle the ongoing real estate fiasco, but that most of the measures that have been taken thus far have been on trying to shore up demand for real estate. The IMF recommends China deal with an oversupply of real estate to solve the market problems.

"We are hoping that once the risks are addressed, we're not gonna end up in a situation with a contagion within China and beyond."

The IMF notes in its report that financial stress in the real estate sector could end up spilling over to the rest of the financial sector.

"Should concerns about financial stability in China fester, the impact could be felt in other emerging market economies through exchange rate volatility and destabilizing capital flows," the report reads.