Iran conflict, the Strait of Hormuz and stagflation risk

17/3/2026

A detailed political map showing the Strait of Hormuz, the critical maritime chokepoint between Iran to the north and Oman and the United Arab Emirates to the south. Red markers indicate key ports like Bandar Abbas and Dubai.

by Henry Cobbe CFA, Head of Research, Elston Consulting

The US/Israel conflict with Iran threatens to slow growth and re-accelerate inflation
Similar to 2022, the combined risk of stagnant growth and persistent inflation, or “stagflation,” is negative for Equities and Bonds alike until there’s an end insight to the oil supply shock
The facts have changed since the outlook at the start of the year, portfolios should also reflect the changing risk outlook

Stagflation Risk 2026: Navigating the Strait of Hormuz Oil Shock

Strategic miscalculation

The US/Israel strikes on Iran, and Iran’s significant and extensive retaliation on US regional bases, Israel, Gulf neighbours, and international shipping was the worst case scenario envisaged. The conflict is a tragedy for the region for the humanitarian and economic crises it unleashes. It seems that the US administration has miscalculated the risks of its actions. It was hoping for a short “shock and awe” campaign against the regime’s military and security infrastructure, and for civilian protestors to rise up and topple the regime, with the former Shah’s US-based son waiting in the wings to form a Government of unity. That still may be the long-term objective, but in the near-term that plan has failed. The miscalculation has been threefold.

Firstly, following decapitation strikes, the Iranian regime was already prepared with a “mosaic” distribution of power with regional commanders ready to continue to act independently. Secondly, compared to last year’s “token” one-off retaliation for the one-off US bombing raid, Iran’s retaliation was maximalist aiming to inflict military losses on the US in the region, economic losses on Gulf neighbours that host US bases and attack oil tankers and infrastructure in the Gulf. Thirdly, whilst the US is targeting traditional weaponry - missile launchers and the Iranian navy, Iran can do sufficient economic and psychological damage with plentiful cheap drones, naval drones, and mobile anti-ship missiles. These “asymmetric” capabilities means it costs the US more to fight, and less for Iran to fight back. With Iran’s regime proving to be resilient, there is no pressure to return to negotiations, or to reopen the Strait. This has been the major US/Israel miscalculation.

Duration of the supply shock

The duration that the Strait of Hormuz remains closed to international shipping determines the height of the oil price spike and the length of time it lasts. Even after any cease fire, Iran’s major card is keeping the Strait closed (whilst allowing shipping of Iran’s allies - Russia and China and non-aligned India - to sail through). The longer the Strait stays closed, the greater the risk to inflation and economic growth. The chart below shows an estimate of oil price paths depending on the duration of the closure of the Strait of Hormuz. In 1973, the oil embargo ended after 6 months.

A line graph titled 'Oil Hinges on Hormuz' showing Brent crude price projections from late 2025 through September 2026. The chart illustrates four paths: a stable 'Pre-war path' at $70, a spike to $100 if closed for 1 month, $135 for 2 months, and a peak near $160 if the Strait is closed for 3 months.

What about strategic reserves

The International Energy Association (IEA) and member countries all have strategic reserves to insulate economies from a shock of this nature. The IEA announcement of a record 400m barrels of oil to be released from strategic reserves (led by the US) covers just 20 days of lost volume through the Strait and will take weeks or months to come to market. Production increases could deliver a further 2mbpd (million barrels per day) - not enough to offset lost volume. Easing sanctions on Russia, makes it easier for India to buy oil (and Russia receives a better price), but does not create more volumes. If the Strait remains closed for longer than 20 days, then the reserves don’t make a difference. Rebuilding those reserves will also provide support to the oil price once the Strait reopens.

What it means for markets

Near-term: Whilst the oil price shock is persisting, there is a rationale for “owning the problem” by including an allocation to diversified assets such as direct Oil, Natural Gas, broader Commodities and Energy companies, as well as Gold - a traditional geopolitical shock absorber and inflation hedge.
Medium-term: The conflict has already lasted longer than markets initially expected. This does force a reassessment of assumptions around 1) inflation and 2) global growth.

Oil shock and inflation: 2022 revisited

Oil, petrol, diesel and gas prices are all interlinked, so an oil price spike has a direct impact on inflation and the cost of living. Higher oil prices mean it’s more expensive to fill a car with petrol or to heat a home with gas. Direct and indirect energy makes up 14.5% of the UK inflation basket. With these costs moving sharply upwards, the longer they remain elevated, the greater the risk that UK (and US) inflation re-accelerates. Having declined close to the 2% target, it could now increase to +5% over the coming 12 months, depending on how long the Strait remains closed.

The chart below shows the relationship between UK inflation, wage growth and interest rates. The difference between 2022 and now is that unemployment is higher: this may deter the Bank of England from raising rates - so a holding decision seems more likely.

A multi-line chart titled 'The BOE Must Decide How Far to Tolerate the Shock' tracking CPI inflation (orange), BOE benchmark rates (black), and regular wage growth (grey) from 2005 to 2026. Key historical shocks like the Financial Crisis, Pandemic, and Russia-Ukraine invasion are annotated, showing inflation currently spiking back above the 2% target.

Chart: Bloomberg.com

Ensuring portfolio resilience

In our Investment Committee discussions, we continue to focus on how to ensure portfolio resilience in face of these changing risks.

Similar to the 2022 Russia/Ukraine invasion, energy crisis and inflation scenario:

Equities look vulnerable to recession risk, so merit a review on overall allocation. Within equities, a preference to Value and Yield factors is more inflation resilient.
Bonds which looked attractive at the start of the year (increasing real (inflation-adjusted) yields, falling interest rates), look unattractive (decreasing real yields), steady or higher interest rates).
Alternatives look attractive as a way of selectively gaining access to asset classes positively correlated with inflation such as Copper, Oil and Gold - (the “COGs”) - as well as broader Commodities and other inflation-resilient asset classes.
Money Markets and Floating Rate Notes: in an environment where interest rates remain higher for longer, money market instruments and Floating Rate Notes aligned to Central Bank policy rates become more attractive as well as acting as a volatility dampener.
Currency: despite the structural long-term challenges for the US Dollar, in “risk-off” moments, it is still a relative safe-haven asset, so a tilt to Dollars in Bond and Money Markets provides diversification alongside Sterling.

When the facts change dramatically, as they have done with the 2026 oil price shock, it is prudent to adapt asset allocations accordingly to mitigate the revised risk outlook.

Asset Allocation Research for UK Advisers