The City woke to the thunder of war this morning. The US launched airstrikes on Iranian targets following a missile attack on a British-linked cargo vessel in the Gulf. For those of us who track the bottom line, this is a seismic shift. The immediate reaction? Oil prices spiked 4% at the open, Brent crude touching $92 a barrel. Gilt yields wobbled, with the 10-year dipping as capital scurried for safe havens. The FTSE 100 opened lower, weighed by energy costs and uncertainty.
Let’s be blunt: this is a fiscal disaster waiting to happen. Government spending always balloons when the guns start firing. Defence budgets? They’ll be revised upward. The Treasury will have to borrow more, and that means gilt issuance rises. But with inflation still sticky at 3.2%, the Bank of England faces a devil’s bargain. Do they tighten further to fight inflation, risking a recession? Or do they hold steady, letting the war premium feed through?
Capital flight is already visible. Sterling dropped half a cent against the dollar as investors fled to the greenback. The Swiss franc and gold are both up. The old ‘risk-off’ playbook is out, and it’s getting dog-eared. For UK pension funds, already battered by the Liability Driven Investment crisis, this is another headache. Duration risk in bonds? They’ll be hedging like mad.
The oil shock is the real killer. Every 10% rise in crude adds about 0.5% to inflation over a year. That’s a direct hit on consumer spending power. Retailers will groan, and the leisure sector will suffer. But airlines? They’re already hedged, mostly. The smart money is watching the energy stocks. BP and Shell are up this morning, but that’s just the initial reflex. If this escalates, supply routes through the Strait of Hormuz could be threatened. That’s 20% of global oil transit.
Now, let’s talk about market efficiency. The strike was precise, but the market hates uncertainty. The VIX jumped 15% overnight. That’s not panic; it’s repricing. Options markets are pricing in a 30% chance of further escalation. The risk premium on Iranian sovereign debt? It’s now junk, effectively. And the UK’s exposure to Iran via trade is minimal, but the indirect effects are massive.
I’ve seen this play before. The Falklands, the Gulf wars, Libya. The pattern is always the same: a short-term spike in volatility, then a grind higher for energy, and a gradual erosion of government finances. The difference this time? Inflation is already elevated. Central banks are caught between a rock and a hard place. The Fed and the Bank of England cannot afford to be dovish, but they also cannot afford to crush growth. Expect hawkish rhetoric but perhaps a pause in rate hikes.
For UK investors, the message is clear: diversify away from sterling-denominated assets. A weak pound is on the cards. And watch the gilt market. If the government announces a ‘war budget’ with more borrowing, yields could spike. That would be a slow motion accident. The BoE might need to intervene again, as they did in September 2022. But that would be a political minefield.
Finally, a word on fiscal responsibility. Defence spending is a necessary evil, but it’s still an expense. The Treasury will have to find the money somewhere. Either cuts elsewhere or more debt. Neither is palatable. The Chancellor will be under pressure to delay fiscal tightening. That’s short-term happy, long-term sad. I’d be selling UK gilts and buying gold. The bottom line: war is expensive, and the bill always comes due. Pay attention to the yield curve. It’s flashing warning signs.
