The City of London has been here before. A fragile ceasefire, a sudden escalation, and the Treasury’s bond markets twitch with nervous energy. This morning, the Foreign Office issued a stern warning to Israel following airstrikes on Beirut that risk unravelling the US-brokered truce with Hezbollah.
From a fiscal perspective, the timing could not be worse. The gilt market, already jittery over inflation and a widening deficit, now faces the prospect of geopolitical risk premium being repriced into UK sovereign debt. One senior trader remarked that the ‘Israel-Hezbollah flashpoint is another headwind for sterling.
’ The government’s response has been measured but firm, calling for restraint and de-escalation. But for those of us who watch the real economy, the calculus is simple: instability in the Middle East means higher oil prices, which feeds through to higher inflation, and that means the Bank of England must keep rates higher for longer. Capital flight to safe havens has already begun, with the dollar strengthening against sterling this morning.
The truce, such as it was, was always a fragile thing. The markets are pricing in a renewed risk of conflict. And that, for the Chancellor, is a very expensive problem.
