Leonard Hong

Prolonged Consequences of the Iran War

A Global Energy Shock with Domestic Consequences

New Zealand is facing an ongoing macroeconomic challenge because of the Israel-US military invasion of Iran in February 2026. The sudden shock to the energy sector caused by the war led to a significant oil price shock, with uncertain duration for the world economy.

The International Energy Agency (IEA) described the situation as the “largest supply disruption in the history of the global oil market.”

Despite yesterday's announcement of a two-week ceasefire, the outlook remains highly uncertain. The current Trump Administration has demonstrated unpredictability in its approach, often operating from a zero-sum perspective in international relations.

A Fragile Domestic Starting Point

Our current circumstances are not optimistic either. Our domestic economy has stagnated for the past couple of years, with our GDP per capita dropping by 3.9 per cent since 2023.

Inflation has dropped from 7.2% to 3.1% as of December 2025, and it is anticipated to worsen significantly beyond the Reserve Bank of NZ's 1–3% target range.

From a fiscal policy standpoint, the New Zealand government is currently stuck, as its attempt to consolidate fiscal policy by 2028 is already at risk due to higher fiscal deficits under the previous Labour government, caused by declining tax revenue and weak demand.

This is not only a shock; it is a macroeconomic shock that is impacting an already fragile, potentially stagflation-prone economy.

Transmission Through Prices and Costs

For New Zealand, this presents immediate cost pressures and potential longer-term risks to inflation, consumption, and investment decisions. There is a very high likelihood of renewed inflationary pressure if elevated oil prices persist. Households would already have felt pressure on their disposable incomes.

The rising fuel costs are especially pertinent, given a 140% increase in diesel since the start of the US-Iran War, which is more expensive than both 91 and 95 fuels. Many businesses that rely on industrial logistics and the transport of goods and services will witness rising input costs across various sectors, including the primary and manufacturing sectors.

Policy Constraints and Trade-offs

The New Zealand government opted to use public finance to support both households and businesses from further consequences. The government has already committed to using the operational allowance to support low-income families with $50 per week, at a cost of $373 million over a 12-month period.

Monetary policymakers at the Reserve Bank of NZ will have an even greater challenge. Our central bank has tried to balance financial stability and inflation, with the Official Cash Rate remaining at 2.25% while simultaneously issuing a hawkish warning that “inflation is likely to become more persistent.” Achieving the delicate balance between preventing even higher inflation and maintaining macroeconomic stability will be extremely difficult.

Structural Vulnerability to Energy Imports

Unfortunately, what is clear is that the cost-of-living crisis facing New Zealand will not wane. We face higher relative risks than other nations because of our heavy reliance on external markets for refined fuel. The New Zealand economy is extremely vulnerable due to its dependence on external parties for energy security.

New Zealand’s exposure to this shock differs from that of other countries. Unlike larger, more energy-independent economies such as Norway, our country operates across long supply chains and relies on transport-intensive industries.

Our current energy sector relies heavily on two East Asian trading partners, South Korea and Singapore, which supply 80% of our refined oil imports. Although we have a sustainable electricity sector powered by abundant renewable energy, our oil and gas sector depends on imports.

External Imbalances and Exchange Rate Pressure

The consequences extend beyond higher petrol prices. Rising fuel costs flow directly into domestic prices, squeeze household incomes, and increase businesses' operating costs. In an economy already experiencing weak growth, these pressures are more likely to compound than dissipate.

There are also important implications for New Zealand’s current account position. Higher fuel import costs will widen the current account deficit, increasing reliance on foreign capital at a time when global conditions are uncertain. Confidence across the New Zealand economy is softening again, comparable to those seen during the Global Financial Crisis. Even if our low-valued dollar has contributed to higher exports and a positive trade balance, this reinforces inflationary pressures.

Sectoral Exposure: Agriculture Under Pressure

The agricultural sector is particularly exposed. Farming in New Zealand is highly dependent on fuel for machinery, irrigation, and transport, as well as energy-intensive inputs such as fertiliser and feed. With higher costs, farm margins will come under significant pressure, resulting in reduced investment and even slower growth.

From Temporary Shock to Persistent Weakness

In a prolonged shock scenario, these dynamics risk reinforcing each other. External pressures feed into domestic weakness, and domestic weakness limits the economy’s ability to adjust. This is how a temporary shock can evolve into a more persistent, low-growth and high-cost environment.

Scenario Outlook Under Uncertainty

We can anticipate a few scenarios that could emerge based on our understanding of contemporary macroeconomic conditions.

If the ceasefire in Iran continues beyond the two-week period agreed yesterday, the conflict would be short-lived. While oil prices initially rise due to uncertainty and risk premiums, markets would gradually stabilise as supply chains adjust and geopolitical tensions do not escalate further. Financial markets would price in a short-lived shock with limited medium-term implications.

Secondly, a prolonged scenario is plausible where the conflict persists without a clear resolution. Markets would remain volatile with periodic price spikes reflecting ongoing geopolitical risk. This could resemble, but exceed, the shock following the Russian invasion of Ukraine. The shock becomes embedded in the domestic economy rather than remaining temporary.

Thirdly, rapid geopolitical escalation cannot be ruled out. A severe escalation could result in a global depression, with widespread stagflationary conditions, sharp increases in input costs, and heightened currency instability.

Shifting Global Order and Strategic Implications

Finally, the diversification away from the US dollar is likely over the longer term. As the world's reserve currency, the dollar depends on investor confidence. However, rising US debt levels and the geopolitical use of financial systems may weaken that confidence.

As noted by economist Kenneth Rogoff, the global economy may pivot further towards Asia, with increased reliance on alternative monetary systems such as the Yuan.

For decision-makers across the private sector and government institutions, forward planning and scenario analysis will be critical. Investment allocations may need to shift towards more stable markets across the Asia-Pacific.

Governments should also consider strategic hedging by maintaining constructive relationships with both the United States and China.

Conclusion: A Test of Economic Resilience

The US-Iran War represents more than a temporary geopolitical disruption. It is a stress test of New Zealand’s macroeconomic resilience in an increasingly fragmented global order.

For policymakers and market participants alike, the challenge is not merely to respond to immediate pressures but to adapt to a world characterised by recurring supply shocks and deep uncertainty.

Economic resilience will depend on prudent macroeconomic management and a more strategic positioning within the Asia-Pacific region to safeguard long-term stability and prosperity.