Markets optimistic about war

US president George W Bush's ultimatum to Iraq yesterday removed one of the major things overhanging markets. Uncertainty.

Wednesday, March 19th 2003, 6:40AM

Consequently sharemarkets around the world rallied on the news that a date for war had been set. The Dow Jones industrial average jumped 3.6% on Monday, the NZSE50 index was up by 1.22% and Australia's market recorded its biggest one day rise since October 1997 rising 3.5%.

Now it appears a date has been set the next big questions are how long would a war take and what impact will it have on markets and economies?

"The key thing for the financial markets is how long will it last," New Zealand Funds Management economist Chris Green told the recent FundSource conference.

He says that the impact of war on the global economy is likely to be impacted by the state of the economy at the start of the conflict.

"Political crises have tended to be overshadowed by the broader economic and investment environment."

Because the US is experiencing a "fragile" recovery it has a reduced ability to absorb the shock of a war.

Consequently "there is more potential for war to derail the recovery," he says.

Although this is a significant negative for investors there are some positive factors (mostly around oil) to consider too.

Green says that real oil prices are less than half their 1980 peak and that oil now makes up a smaller component of GDP than it has in the past. Also there is little threat of an OPEC boycott and more supplies of oil are available now that Russia is a net exporter of black gold.

He says if a war starts there will be three immediate impacts. Firstly the cost of the conflict (which the US prices at US$85 billion), secondly higher oil prices occur (and this has the effect of being a tax on spending) and thirdly weaker business and consumer confidence.

Looking at the impact of a war there are three scenarios the markets need to consider and he has given each of these a probability.

The least probable (15%) is a peaceful resolution which would allow a gradual economic recovery to proceed and would leave oil prices and bond rates relatively static.

The most probable scenario (65%) is a short, decisive war which would lead to a more rapid economic recovery. Oil prices would spike briefly and then fall to US$20 by 2004 leading to a more rapid economic recovery. Bond rates would start rising.

The middle, and least desirable scenario (20%), is a protracted war which would lead to a renewed economic downturn and recession. Consequently oil prices would go higher and bond rates would fall lower with the US 10-year rate likely to hit 3.5%. Green says sharemarkets could fall by more than 20%.

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