Oil prices surged more than 5% on Monday after US airstrikes on Iranian targets in the Gulf sent shivers through already jittery markets. Brent crude breached $90 a barrel for the first time since October, as traders priced in the risk of a broader conflict that could choke the Strait of Hormuz, through which a fifth of the world’s oil passes. The British government, in a carefully worded statement, called for 'restraint on all sides' while avoiding direct criticism of its American ally.
But the City of London is under no such diplomatic constraint. The FTSE 100 dipped 1.2% as defence stocks soared, and gilt yields rose sharply on fears that higher energy costs will keep inflation sticky.
This is exactly the sort of geopolitical shock that central bankers dread. The Bank of England, which had been toying with rate cuts later this year, now faces a fresh headache. If oil stays above $90, inflation could remain above target for months, forcing policymakers to keep borrowing costs higher for longer.
The capital flight story is also worth watching. The dollar strengthened against sterling and the euro as investors fled to safe havens. Emerging markets, already struggling with debt, could be hit hardest by rising import bills.
The irony here is that the US strikes were ostensibly about deterrence, but the market reaction suggests they have achieved the opposite. Iran has already threatened to close the Strait of Hormuz if its security is threatened. That would send oil towards $130, something the global economy can ill afford.
The only winners so far are the energy majors and perhaps the Treasury, which will see a windfall from higher North Sea oil taxes. But for consumers and businesses, this is a nasty reminder that the world remains a dangerous place. The big question is whether this is a temporary spike or the start of a sustained surge.
My bet is on the latter. The geopolitical risk premium has been remarkably low for months. This correction was overdue.
Britain’s call for restraint is sensible but unlikely to matter. The US and Iran are locked in a cycle of escalation that neither seems able to break. In the meantime, hedge your portfolios accordingly.
Cash is finally yielding something, and gold is shining again. The bottom line: governments rarely restrain themselves, but markets always do.
