The bond markets, my friends, are a better barometer of geopolitical risk than any chorus of diplomats. And this morning, as news filters in of Israeli strikes killing 22 in Lebanon, the yield on the 10-year gilt has crept up a few basis points. Not a panic, not yet. But a definite twitch. The City is pricing in the premium of uncertainty.
The government’s plea for an immediate ceasefire, delivered with all the moral weight of a Treasury minister reading a pre-approved statement, is the predictable response. Britain urges restraint. Britain calls for de-escalation. Britain, in short, does what Britain always does: wrings its hands and hopes the storm passes. But the storm is not a British storm. It is a Levantine firestorm, and the sparks carry.
Let’s examine the balance sheet. Twenty-two dead in Lebanon. That is a tragedy, and I do not diminish it. But from the vantage point of a financial editor, the numbers that really matter are the ones on the spreadsheets of the Israeli defence ministry and the Lebanese central bank. A war is a devastating drain on capital. It distorts fiscal policy, crowds out productive investment, and sends risk-averse capital scurrying for the exits. We have seen this movie before. In 2006, the conflict with Hezbollah cost Israel an estimated $1.6 billion in direct military expenditure and double that in lost GDP. The Lebanese economy, already a basket case, was pulverised.
Now, the dynamics are worse. Hezbollah is more entrenched. Iran is a more direct patron. The Israeli government is more hawkish. And the global economy is more fragile, with inflation still sticky and central banks skittish. A full-blown regional war would send oil prices through the roof, hammer supply chains, and give the Bank of England a perfect excuse to keep rates higher for longer. That is the nightmare scenario for the gilt market. For now, the market is treating this as a localized escalation, not a general war. But the volatility index is ticking up. The VIX on Wall Street, the FTSE’s own measure of anxiety: both are edgy.
The government’s call for a ceasefire is sensible, of course. But it is also a confession of impotence. Britain has no leverage. Our foreign policy in the Middle East is a footnote to American strategy. The real lever is in Washington, and even there, it is rusty. The US administration is distracted by its own electoral cycle. So the calls for peace will ring hollow in Tel Aviv and Beirut.
Meanwhile, the fiscal arithmetic is grim. The UK already carries a debt-to-GDP ratio of over 100%. A prolonged conflict in the Middle East would impose costs: higher defence spending, higher energy prices, higher borrowing costs. The government talks of ‘fiscal headroom’. There is none. It is a mirage created by optimistic GDP forecasts.
The bottom line? This is a risk event. Portfolio managers should be looking at their exposure to emerging markets, to energy, to defence stocks. The safe haven bids will lift the dollar, depress the pound, and make the Bank of England’s job even harder. If you own gilts, you are betting that British restraint will triumph over Middle Eastern chaos. I would not take that bet.
The City is watching. The yield curve is steepening. The pound is wobbling. And the government’s ceasefire plea is just background noise. In the market, we deal in probabilities, not hopes. And the probability of a wider conflagration has just gone up.
I will be watching the 10-year gilt yield closely. If it breaks above 4.5%, the market is telling you something. You would be wise to listen.
