If oil prices do not fall, the global economy can only move toward "slow growth + high inflation."

Oil prices staying stubbornly high are pushing the global economy toward an unsettling macro scenario—slowing growth coexisting with stubborn inflation. Morgan Stanley warns that the real risk is not a one-off sharp shock from oil prices, but the deeper effects caused by oil prices remaining high for the long term and failing to recede for some time.

According to the Tracker Trading Desk, in its latest report, a research team led by Morgan Stanley’s Chief Global Economist Seth B Carpenter points out that even if geopolitical tensions around the Strait of Hormuz are not further intensified, they may still sustain partial restrictions on crude oil supply for a considerable length of time—keeping oil prices loaded with a persistent geopolitical premium.

In this scenario, the global economy faces not a temporary price shock, but a prolonged rise in energy costs—its macro impact will be far more complex than any oil-price shock in history, and it will show a clear stagflation-like pattern.

The direction of this shock is stagflationary. As a result, monetary policy and fiscal policy will diverge significantly, producing markedly different effects on different economies. For investors, this means that rate-cut expectations need to be repriced, and differences in each country’s policy path will become a key variable for asset allocation.

Inflation risks are being underestimated: second-round effects are more persistent than in history

Morgan Stanley notes that the fundamental difference between this oil-price shock and past ones lies in the “persistence” of prices rather than their “peak.” In previous oil-price shocks, prices often fell quickly after rising, naturally shortening the duration of inflation pass-through.

But if oil prices remain at high levels for a long time without mean reversion, companies will face a protracted cost shock. Their ability to absorb costs by compressing profit margins will gradually run out, and they will ultimately have to pass the pressure on to the price level.

This means that even if the year-over-year growth rate of energy prices mathematically narrows over time, the second-round effects—namely, the pass-through of energy costs to the prices of broader goods and services—will be more stubborn than what historical experience has shown. Therefore, even if headline inflation data appear to improve on the surface, inflation risks still lean upward.

At the same time, while growth slows, it will not collapse. Sustained high energy costs are effectively an implicit tax on consumption and corporate profit margins, dragging economic activity in both developed and emerging markets. This drag effect takes time to fully show, but its impact cannot be ignored. A global recession resulting from this scenario would mean that the disinflationary shock brought by slowing growth would be insufficient to offset the upward push from the second-round effects—thereby forming a stagflation pattern.

Monetary policy divergence: the Fed stays put, the ECB leans toward rate hikes

Faced with stagflation pressure, major central banks’ policy stances have diverged clearly, and this will be a core variable affecting global interest-rate markets.

Central banks that are more sensitive to inflation expectations—especially the European Central Bank and the Bank of England—tend in the current environment to tighten policy further. According to their latest forecasts, the ECB’s next step is a 25-basis-point rate hike, with the timing expected in June 2026; the Bank of Japan is also expected to hike rates by 25 basis points in June 2026.

By contrast, the Fed’s situation is more complex. The Fed will choose to pause rather than cut rates, and this pause could last for quite a long time. Its baseline forecast shows that the window for the Fed’s next 25-basis-point rate cut is September 2026, assuming that inflation expectations do not show a clear drift upward. If inflation expectations show upward signals, the Fed could even keep a restrictive policy stance in place through 2027.

The reaction of emerging-market central banks is more dispersed, highly dependent on each country’s fiscal situation and external vulnerabilities, making it difficult to form a unified policy direction.

Fiscal policy: the double-edged sword of energy subsidies further intensifies global divergence

On the fiscal policy front, how governments respond will deeply affect the inflation trajectory and further intensify the divergence in the global macro landscape.

Many governments are leaning toward broad price-control measures, including cutting fuel taxes, setting price caps, or implementing universal subsidies—shifting the cost burden from households to public or quasi-public balance sheets. While these measures can provide short-term cushioning, they distort price signals, support demand, and may keep inflation elevated for the long run—especially when these measures are constrained by fiscal space and cannot be sustained.

For energy-importing emerging markets with limited fiscal space, broad subsidies can damage the balance of external accounts and policy credibility. Energy-exporting countries benefit from improving terms of trade, and some can also obtain additional fiscal revenue. This divergence is precisely the deep reason behind the highly differentiated policy stances among emerging-market central banks—and the difficulty of coordinating them.

By comparison, countries that take more targeted support measures—focusing on vulnerable households or specific industries while allowing energy prices to transmit more fully to the market—may place more near-term pressure on consumers, but have lower fiscal costs and more controllable inflation shocks. The trade-off is greater downside risk to growth. Given the currently high level of debt, rising financing costs, and the renewed tightening of fiscal rules, the likelihood of large-scale fiscal intervention is limited unless recession risk rises substantially.

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