The Middle East conflict between Israel, Hezbollah, Lebanon and Iran has been simmering but the response of Iran to Israel’s assassinations over the last several weeks targeting Hezbollah leaders, which resulted in the bombing of the Beirut hiding place of the militant group’s chief Hassan Nasrallah, has sent oil prices up and share prices down.

This could be bad news for inflation and then interest rates, with oil prices on the rise. This would feed into other prices and send the Consumer Price Index (CPI) up, which would make it hard for the RBA to cut rates.

The first reaction to Iran’s retaliation saw oil prices climb more than 3% on Tuesday in the immediate aftermath of Iran sending 200 ballistic missiles to Tel Aviv. However, if this war gets more serious, in turn we’ll see a more serious spike in oil prices.

Ominously, Israel’s Prime Minister Benjamin Netanyahu has promised to retaliate and that’s bound to lead to more fear and anxiety for financial and commodity markets. Uncertainty will always be a negative for stock markets and that’s what’s prevailing right now, as the world awaits Israel’s next move.

That said, on Wednesday, the market concerns were contained, with stock market reactions mixed. Our market lost only 0.13%, while the Hong Kong market was up over 6% and the Shanghai index surged 8% on the China stimulus news, which is seen as more market moving than the Middle East.

In Europe, the German and Italian markets were down around 0.25% but the UK and French bourses were up! And the Yanks kept it positive, with all three closely watched indexes up, but the gains were small, all less than 0.01%.

Markets are nervous but not panicking. But oil prices will spike significantly if Israel and Iran get seriously engaged in missile madness.

This is a pretty typical take on how Wall Street and other stock markets are viewing the developments between Israel and Iran. “We’re really seeing the market have a little bit of a hiccup with this recent spike in geopolitical tensions,” said Lisa Erickson, head of public markets due diligence, at U.S. Bank Wealth Management. “While investors typically don’t worry too much about those events until there’s a clear economic impact, we’re just seeing some nervousness.” (CNBC.com)

Here’s how Investopedia has looked at the impact of war on markets:

KEY TAKEAWAYS

• Though war and defence spending can amount to a sizable portion of US GDP, wars often have little sustained impact on stock markets or economic growth at home.
• Markets largely have ignored recent conflicts related to the Middle East and Iran.
• A broader regional war, however, may have a more severe impact, especially on oil and other commodity prices.
• Still, stock markets have often quickly recovered to pre-invasion levels only a matter of days or weeks after armed conflicts or standoffs begin.

The real story is the response of oil prices and stock prices will depend on just how bad this conflict becomes. If it becomes a full-on ground war, then the impact on oil supplies could see a significant short-term fall in stock prices. But given the history of stock markets, I’d see this as a buying opportunity.

Echoing my views, here’s the view of Mohamed A. El-Erian, chief economic adviser at Allianz (who also writes for Bloomberg) on how geopolitical concerns affect markets: “Over the last few years, markets have been conditioned not to overreact to political and geopolitical shocks for two reasons: first, the belief that there would be no significant subsequent intensification of the initial shock; and second, that central banks stood ready and able to repress financial volatility.”

You have to hope he’s right on both scenarios.