What’s the Connection Between The Strait of Hormouz Closure, Global Price Stability, and Geopolitical Risk?

PRS’ risk governance board met yesterday as we’re looking more closely at the so-called ‘Hormuz shock’ – a reference to the oil artery for 20% of global oil, which faces unprecedented threats. The idea being seriously discussed is both the “triple shock” to global price stability (geopolitical, trade, currency), but also the deeper structural risks at play.

We discussed the long-term inflationary threat posed by the closure and the larger conflict and considered the 42+ ICRG political risk series. The suggestion was that that such geopolitical “shocks” aren’t mere temporary fluctuations but fundamental drivers of price volatility.

So we then looked at the research that uses the ICRG data series, which offers three crucial insights relevant to our current situation:

1/ Seminal research by Ari Aisen and Francisco Veiga (widely cited by the IMF) confirms that a deterioration in a country’s ICRG political stability score is a statistically significant predictor of higher inflation. The logic here is that as governments in the Middle East face extreme pressure, their ability to manage fiscal discipline erodes, often leading to “inflationary financing.”

2/ Then there is the sovereign risk premium, as studies have shown that a 10-unit drop in ICRG risk ratings is associated with significantly higher sovereign spreads. Inter alia, this “geopolitical tax” can force central banks to raise interest rates to defend their currencies, which could further embed inflation into the domestic economy.

As external conflicts and commodity spikes can have a significant impact on inflation expectations, geopolitical risk shocks, particularly in energy-sensitive corridors like Hormuz, can disrupt supply chains and cause de-anchoring of inflation expectations for a longer period than simple price spikes would indicate.

The current situation is characterized by historic lows in Iran’s External Conflict and Government Stability scores. According to the ICRG data, what we are seeing is not only a “high oil” event but the possible re-pricing of global risk that will likely keep inflation elevated for the foreseeable future.

As such, the Political Risk Rating will become just as crucial in future inflation modelling and the CPI print.

Our data drives
The PRS Group