After decades of brinkmanship, the unthinkable has occurred. A deal between Washington and Tehran has been struck, ostensibly to end the shadow war that has plagued the Middle East. The news hit London markets like a shockwave. Brent crude dropped 12% in early trade, the steepest single-day decline since the 2020 pandemic crash. At the Treasury, officials are scrambling to update their inflation forecasts. For the average Briton, this is not about geopolitics. It is about the price of petrol and the weekly grocery bill.
Let us be clear: peace has a price, and it is not always low. The immediate market reaction is predictable. The oil risk premium evaporates, sending crude prices crashing. This will feed directly into lower fuel costs at the pump, which the Office for Budget Responsibility will be quick to highlight as a boost to real incomes. But the story does not end there. The deal, as rumoured, includes the lifting of sanctions on Iranian oil exports. This could flood a market already braced for supply constraints. The International Energy Agency warned this morning that global spare capacity may be less than assumed. Yet, if Iranian barrels return in force, we could see a sustained period of low energy costs.
However, the anti-inflationary benefit may be offset by higher direct food costs. Iran is a significant producer of fertiliser and a key transit route for grain from the Caspian region. The deal includes provisions for agricultural investment, but the disruption caused by the war has not vanished overnight. Supply chains remain fragile. UK food importers are already reporting that Iranian exporters are demanding higher prices for new contracts, citing pent-up demand. The net effect could be a bumpy path for the Consumer Prices Index.
The gilt market, my true barometer of fiscal sanity, is showing signs of nervousness. Despite the dip in oil prices, the 10-year yield ticked up three basis points this morning. Why? Because the market is now pricing in a massive shift in geopolitical risk allocation. The US may reduce its military footprint in the Gulf, but that does not mean defence spending falls. The Treasury has already indicated that the UK's overseas aid budget, cut during the pandemic, will not be restored to previous levels. The fiscal headroom from lower energy costs could be quickly swallowed by increased welfare spending as the cost of living crisis eases only slowly.
Capital flight from emerging markets may also destabilise currencies. As tensions ease, money that had sought refuge in the dollar and gold will rotate back into risk assets. The pound could gain against the dollar, which is good for imports but bad for exporters. The Bank of England faces a dilemma: lower inflation from cheaper oil gives room to cut rates, but currency appreciation could dampen the recovery. The hawks on the Monetary Policy Committee will be cautious. They remember the false dawn of 2008 when commodity prices fell sharply only for inflation to reignite.
There is also the question of long-term fiscal discipline. The Chancellor of the Exchequer is reportedly 'monitoring the fallout'. That is Treasury speak for 'we have no idea what to do'. The deal may bring peace, but it also brings uncertainty. The market hates uncertainty. The best course is to let the oil price pass through fully to consumers. Do not tempt to tax the windfall. Let the savings stimulate demand and trust that the Bank of England will manage the inevitable gyrations.
In the City, we are breathing a cautious sigh of relief. But we know better than to trust a lasting peace. The Iran deal is a trade that could turn sour if implementation falters. For now, buy the dip. But keep one eye on the horizon. The cost of war is high, but the cost of peace can be equally unpredictable. The bottom line: lower oil prices are a short-term boon. The long-term fiscal arithmetic remains unsettled. The Treasury would be wise to bank the peace dividend and not spend it twice.
