The latest round of US-Iran negotiations has been described as showing ‘encouraging progress’, a phrase that will do little to soothe the nerves of London’s institutional investors. The Foreign Office, ever eager to sound a moderating note, has called for restraint in the Gulf. One cannot help but detect a hint of desperation, given the region’s status as the world’s most volatile oil chokepoint.
Let us examine the numbers. Iran’s crude output has been hovering near 3.2 million barrels per day, down from nearly 4 million before sanctions were reimposed. Any relaxation of the US maximum pressure campaign would presumably see that figure rise, putting downward pressure on oil prices. Brent crude, currently trading at $84 a barrel, could easily slip below $80 on a genuine diplomatic breakthrough. That would be a relief for the Bank of England’s inflation hawks, who have been watching energy costs push the CPI above 4% again.
But the market’s real concern is the longevity of any deal. The 2015 JCPOA was torn up within three years. Investors have long memories. Iran’s nuclear programme has advanced far beyond where it was then: enriched uranium stockpiles are estimated at over 30 times the JCPOA limit. A new agreement would require robust verification, and trust is in short supply, especially after Iran’s role in arming Russia with drones.
Britain’s call for restraint is typical of the establishment’s desire to avoid any disruption to Gulf shipping lanes. Some 20% of the world’s oil passes through the Strait of Hormuz. A single mine or missile strike could send the insurance premiums on tankers through the roof, a cost that would be passed directly to the consumer. The Treasury, already grappling with a fiscal deficit of nearly 5% of GDP, can ill afford another energy price shock.
Yet the real story here is capital flight. The mere whiff of détente has buyers piling into Tehran’s equity market. The Tadawul All Share Index in Riyadh, meanwhile, has taken a modest hit as the risk premium on Saudi assets narrows. But do not mistake this for optimism. The pound has been range-bound against the dollar, and gilt yields remain stubbornly high, with the 10-year still yielding over 4.2%. The market is pricing in a ‘risk off’ scenario, not a new era of peace.
Central banks will be watching closely. The Fed and the ECB have both signalled rate cuts this year, but a spike in crude could upset those plans. The Bank of England is especially vulnerable, with wage growth still running at 6% and services inflation proving sticky. A diplomatic breakthrough that lowers fuel costs would be manna from heaven for Andrew Bailey, but he knows better than to count on it.
Let us not forget the domestic political angle. The Prime Minister is eager to project an image of global statesmanship ahead of a likely autumn election. A successful mediation would serve him well, though the public is more focused on mortgage rates and the NHS waiting lists. Foreign policy victories rarely swing votes in the Home Counties.
In summary, ‘encouraging progress’ is diplomatic code for ‘nothing signed yet’. The City will remain sceptical until there is a verifiable agreement on the table. Until then, the bottom line is this: volatility in the Gulf means volatility in the markets. Prudence dictates a defensive posture. Hedge your bets, but do not bet on peace.