By George Brown, Senior Economist at Schroders

Oil prices are volatile as the Iran-Israel conflict continues. Will higher energy prices persist, and could they be inflationary?

Looking ahead: potential outcomes

Similar incidents in recent years have amounted to a limited exchange. Iran's response has typically been sufficient to demonstrate domestic strength without escalating tensions further. So far, this conflict has proved more brutal than other recent escalations. Even so, it remains a direct exchange of fire between Iran and Israel with minimal disruption to the oil market.

The US and several Middle Eastern nations (including those which have already condemned the attacks, such as the UAE and Saudi) have no interest in a flare-up of tensions in the region. Nor do they wish for disruption to global oil markets. Previously they have intervened to calm situations like this.

Israel has stated that the operation will continue for "as many days" as it takes to remove the Iranian threat. But hostilities could settle if Middle Eastern countries and the US mediate a resolution.

What does it mean for oil?

The likelihood of Iran taking any action in the Strait of Hormuz, the often-touted disaster scenario for oil markets, appears remote. Such action would impact flows for the other Middle East nations which are aiming to mediate the situation, while inflicting little harm on Israel.

Iranian oil supply makes up 3.5% of global supply. However, Israel's stated aim has been to impede Iran's nuclear program, consistent with the fact that most strikes so far have targeted Iranian nuclear and military facilities. While oil production facilities remain a potential target for Israel, it has yet to target them directly, quite possibly restrained by the knowledge that pushing oil prices higher would damage its relationship with allies, such as the US.

Outside of the conflict, other dynamics in the market continue to point to a global market oil surplus continuing to build in coming months.

Inflation outlook

Although oil prices are sensitive to this type of conflict, as in previous similar events, the initial price rise moderated in the following hours. If Brent Crude settled at $75 per barrel, it would imply that G7 energy inflation would be a little above 5% over the next year.

Would this lead to broader inflationary pressure? Probably not.

Our previous research on the relationship between oil prices and inflation suggests that every 10% rise in oil prices adds just 0.1% to core inflation.