Global markets are feeling the pressure of soaring energy prices and higher borrowing costs, a development that could usher in a period of stagflation – high inflation paired with sluggish growth. While stock indexes remain close to record levels, fueled by robust spending on artificial intelligence, analysts say the rising cost of oil, diesel, jet fuel and natural gas is beginning to bite.

Energy prices surge amid Middle‑East conflict

Oil futures have climbed back above $100 a barrel, roughly 50% higher than before the recent war in the Middle East. Traders expect little near‑term relief, with Brent crude futures targeting $100 by December and options betting on a $60 sell‑off. Diesel is approaching record highs, jet fuel prices have doubled since February, and European natural gas is at its highest level since 2022 as utilities compete for cargoes.

Inflation picks up again

After easing over the summer, inflation is rising once more. In the United States, headline inflation held at 3.4% in August, while gasoline prices jumped 3.9%. The euro zone saw annual inflation rise to 3.3% in August from 2.9% in July, well above the European Central Bank’s 2% target, driven largely by energy costs. The United Kingdom’s inflation climbed to a five‑month high of 3.1% in August.

The European Central Bank recently raised its inflation expectations to an average of 2.5% for next year, with underlying inflation projected at 2.6% in 2027. Market swaps indicate euro‑zone inflation will hover around 3.5% next year and settle near 2.4% over five years. In the United States, one‑year inflation expectations sit near 2.5% with little change expected over the next five years.

Higher rates expected as energy drives outlook

The war has altered the outlook for global interest rates. Where markets once anticipated central banks would hold or cut rates, traders now price in almost a full point of rate hikes from the European Central Bank within the next year and at least two more hikes from the Federal Reserve after its recent 25‑basis‑point increase. Energy is seen as the primary factor shaping this rate outlook.

The Bank of England left rates unchanged but warned that UK inflation could exceed 4% by early 2027, double its target. The Bank of Japan is expected to raise rates to a 31‑year high, with further increases priced in.

Growth remains resilient but faces headwinds

Despite these pressures, private‑sector activity has stayed strong. Purchasing Managers’ Index (PMI) scores indicated solid expansion in the United States and Europe during July and August. Recent data showed UK growth beating expectations in July and U.S. retail sales exceeding forecasts in August.

These factors have helped underpin equity markets. Second‑quarter earnings for S&P 500 companies are projected to have risen 53% year‑on‑year, according to LSEG I/B/E/S data. However, rising energy costs and a global bond sell‑off have pushed government‑bond yields to financial‑crisis levels, lifting borrowing rates across the board. The average U.S. 30‑year mortgage now exceeds 6.7%, its highest level since June 2025.

Consumers feel the squeeze

Higher fuel prices at the pump and rising household energy bills are straining consumers, especially in Europe where storage levels are at their lowest for this time of year in 15 years. Mortgage and loan rates are climbing while wage growth lags behind.

Investor sentiment reflects these concerns. U.S. consumer‑discretionary stocks have fallen nearly 6% this year, underperforming the S&P 500’s 10% gain. In Europe, consumer‑discretionary shares are down 17% year‑to‑date, the second‑worst performers after luxury goods, while the STOXX 600 index has risen 7.5%.

With interest rates rising, households are more likely to save rather than spend, further limiting domestic economic momentum.

Outlook

Analysts warn that the combination of high energy prices, elevated borrowing costs and persistent inflation could test the resilience of growth. While AI‑driven spending continues to support markets, the looming risk of stagflation remains a key focus for investors and policymakers alike.

Original reporting: Appleton, WI News Feed (HLL/CB) — read the source article.