The drums of war beat louder in the Gulf this morning. US forces have launched precision strikes against Iranian radar installations in southern Iran, a move that White House officials describe as a 'proportionate response' to escalating threats against commercial shipping. UK intelligence sources have corroborated assessments that Tehran is actively positioning missile batteries capable of striking key maritime chokepoints, including the Strait of Hormuz.
For markets, this is a moment of reckoning. The risk premium on Brent crude has already spiked, with futures trading above $95 a barrel at the time of writing. If the Strait is even partially disrupted, we could see a repeat of the 1973 oil shock. The bond market is signalling unease: the 10-year gilt yield has edged up 8 basis points as investors flee to safety in US Treasuries. Sterling is taking a hit, down 1.2% against the dollar.
The Treasury will be watching this closely. Any sustained rise in energy prices feeds directly into inflation, and the Bank of England’s tightening cycle is already under strain. The market’s inflation expectations for the UK have risen by 20 basis points since the news broke. This is precisely the kind of external shock that makes the MPC’s job impossible.
Sceptics will ask: is this a genuine defensive action or a calculated escalatory step? The timing is curious, coming just days after Tehran rejected EU-led nuclear talks. The Pentagon insists the strikes were limited to military targets and that no civilian infrastructure was hit. But in the City, the fear is that this could spiral. Capital flight from emerging markets is already accelerating, with the Indian rupee and Turkish lira both under pressure.
Let’s be clear: the fiscal arithmetic for the UK is worsening. Higher defence spending, increased energy costs, and a potential slowdown in trade. The Chancellor’s headroom for tax cuts is evaporating. Investors are starting to price in a higher risk premium on UK sovereign debt. If the crisis persists, we may see gilt yields push above 5% again.
The key metric to watch is the VIX and the Baltic Dry Index. If shipping insurance premiums for Gulf routes double, then we know the market is pricing in a prolonged disruption. The US has said it will protect freedom of navigation, but words are cheap. The missiles are real.
For now, the advice to portfolio managers is to hedge energy exposure and increase cash holdings. The era of low volatility is over. Central banks will be forced to choose between fighting inflation and preventing a financial accident. My bet is on the former. They always choose inflation control in the end, even if it breaks a few economies along the way.
