The City of London woke to a jolt this morning as news broke of direct strikes between Iran and the United States in the Persian Gulf. A fragile ceasefire, already looking like a house of cards, has collapsed. British troops are now on standby, a move that will do little to calm jittery markets already pricing in a risk premium on Middle Eastern exposure.
Let's talk about the bottom line here. Oil prices are the obvious first domino. Brent crude is already up 4% in early trading. If this escalates, and history suggests it will, we are looking at a supply shock that feeds directly into inflation. The Bank of England, already wrestling with sticky price pressures, will have to factor in a prolonged energy spike. That means interest rates stay higher for longer. The gilt market, which has been on a rollercoaster, will not like this.
Capital flight is another immediate concern. Money hates uncertainty, and there is no greater uncertainty than a shooting war between a nuclear-aspiring state and the world's largest economy. Safe havens: the dollar, gold, Swiss franc. Sterling? It will take a hit. The pound is already down 0.8% against the dollar this morning. Currency traders are not known for their sentimentality.
The Ministry of Defence's statement about 'troops ready to deploy' is carefully worded. It signals solidarity with Washington but stops short of commitment. This is prudent. The last thing the Treasury needs is another unfunded military adventure. Defence spending as a share of GDP is already under scrutiny from fiscal hawks. A prolonged deployment would blow a hole in Reeves's fiscal rules.
Now, to the markets. Defence stocks will rally. BA Systems, Rolls-Royce, the usual suspects. But this is a short-term play. The real question is how long this volatility lasts. If the strikes are a one-off tit-for-tat, markets will recover within weeks. If this opens a wider conflict, all bets are off. The Strait of Hormuz is the choke point. Any disruption there and we are back to 1970s-style stagflation.
The ceasefire was never robust. It was a diplomatic Band-Aid on a bullet wound. Iran's nuclear programme, US sanctions, proxy wars in Yemen and Syria. The ingredients for escalation were always there. Markets chose to ignore them because hope trades at a premium in the City. Now we pay.
What should investors do? Hedge. Currency, commodity, duration. This is not the time for heroics. Corporate bonds with Middle East exposure? Reduce. Cash is not trash when volatility spikes. And watch the US Treasury yield curve. If it inverts further, recession fears will add to the geopolitical panic.
Central banks are in a bind. The Fed and the Bank of England cannot cut rates to cushion the blow if inflation is the byproduct. They will talk about 'monitoring the situation' and 'standing ready to act'. Do not believe the spin. They are as clueless as the rest of us.
The bottom line: this is a market event, not a market trend. But events can become trends if policymakers lose control. The Gulf has a habit of humbling optimists. British troops on standby is a reminder that the world is not as safe as the spreadsheets suggest.
