Trump’s Iran war has broken the world

Iran is a big and rugged country, slightly larger than the UK, France, Germany and Italy combined, and with around 90 million people. The regime has a monopoly on force, through its control of the Islamic Revolutionary Guards Corps and the paramilitary Basij militia. Local commanders  are deployed across the country with considerable autonomy. The IRGC controls a quarter or more of the economy and has had plenty of time to prepare for this attack: cutting off its head won’t destroy its body.

It has a reverence for martyrdom and was the driving force behind Iran’s recovery from the devastation left by its war with Iraq in the 1980s. With this as its backbone, this is not a regime that will be subdued by air power alone.

Trump has called on the Iranian people to take matters into their hands. But dissident groups in Iran remember that’s exactly what president George H W Bush told the Iraqi people near the end of the first Gulf War in 1991. He then abandoned the Kurds in the north and Shia groups in the south to their fate as Saddam Hussein took his terrible revenge. That’s a grim warning about precipitate action against the Iranian regime today.

The second certainty is that the US faces contested midterm elections in less than eight months. This is an unpopular war with Americans, and its impact is already being felt at the gas station with prices up by nearly a fifth so far. Unlike Iran, the US is very unwilling to accept military casualties. 

So Trump faces great pressure to declare victory and leave as soon as possible. He can already claim that he has destroyed most of Iran’s offensive capabilities, and that, in doing so, he has solved a problem that has frustrated the last eight US presidents over a period of nearly 50 years.

But then there’s Israel. The third certainty is that prime minister Netanyahu must call an election by October and will probably bring it forward to capitalise on what, in his country, is an enormously popular war. A regime that has for decades threatened the very existence of Israel is now tottering on the ropes and Netanyahu has a much greater incentive than Trump to go on smashing it and its acolytes for as long as possible.

The immediate question for the world and for the UK is about the supply and price of energy, and the answer depends in large measure on how long the Strait of Hormuz is closed to tanker traffic. 

Roughly a third of the world’s supply of seaborne oil and a large proportion of its liquefied natural gas pass through this waterway, and it only takes a casual aside from Trump about what might happen there to send the price of both commodities spiking up or down. 

Just this week Saudi Aramco, the world’s largest oil company, warned of drastic consequences for the global economy if the war dragged on.

Already there will be great pressure to keep the Strait open, and not just from the US and the Gulf States. China signed a 25-year agreement with Iran in 2021, offering substantial capital investment through the Belt and Road initiative in return for a regular supply of oil and gas. 

It will be pushing hard for a payback now: Gulf imports account for about a third of China’s total oil demand and a big chunk of its LNG. The rest of Asia is also heavily dependent on the same route: last year Asia absorbed more than four-fifths of the crude oil and LNG that passed through the Strait. 

There is an expectation that this pressure will bring results. When the oil price briefly approached $120 on Monday, the oil futures price curve sloped down at a steep angle suggesting a mad scramble for oil in the short term but also the hope that crude would be available at a cheaper rate a month two in the future. That in turn implies a return to something approaching normality in traffic flows before too long.

But it’s going to take a while for the disruption to be sorted out once the Strait is re-opened, and there will be extra risks to take into account given what has happened. At the start of this year when oil was in plentiful supply, market analysts were penciling in around $60 a barrel as a likely price for the coming months. That feels like a long time ago.

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The UK is potentially very exposed to an energy price shock. Two years ago, the Office for Budget Responsibility modeled what would happen in the event of a large-scale disruption to supplies on the scale of the 1973 oil embargo. The results were not pretty. Inflation would rise by 5 percentage points more than previously expected, it estimated, with serious consequences for interest rates and the economy as a whole.

Yet the world’s oil and gas markets have changed beyond recognition in the past fifty years. Iran itself is no longer a key supplier. The US was the world’s largest importer of oil: now it produces more than it consumes and it has also become the leading exporter of gas. The UK economy is less oil-dependent than it used to be.

So the impact on the UK of what’s happening may be relatively contained, but it will not be negligible. Just a few weeks ago, the OBR was forecasting that inflation would be dropping down to 2% in the second half of this year, and the financial markets were pricing in two quarter point interest rate cuts in 2026 with the first probably coming at the Bank of England’s meeting on March 19. 

Now those hopes have largely disappeared, and there’s a chance that the next rate move will be modestly up rather than down. 

David Miles from the OBR told the Treasury Select Committee on March 10 that if energy prices remained where they stood that morning with oil at roughly $90 per barrel, inflation by the year end might run at around 3% – a percentage point above the Bank of England’s target level. That would be a significant change – although not on the scale experienced after the Russian invasion of Ukraine.

 All that would have consequences for the OBR’s expectations of a modest 1.1% rise in GDP this year and an average of 1.6% growth in the years thereafter. And then there’s the potential impact of US tariffs. In the light of his recent comments, Trump might be unwilling to cut favourable deals for the UK in the near future.

There are also fiscal challenges ahead. The UK’s embarrassing inability to deploy military assets on any scale during the crisis will add to the existing pressures for much increased defence spending, in the process bringing back to life the weary old debate about the case for spending cuts or tax increases.

The war brings geopolitical as well as economic risks. Start with the Gulf States, which along with Egypt, Turkey and others are actively opposed to what has happened. The threat to their interests from Iran had visibly diminished, following Israel’s attacks on both it and its proxies and the departure of the Assad regime, its ally, from Syria. They didn’t see the need for urgent action.

The Gulf States’ business model is built on a combination of thriving global energy markets and the promise of peace and security within their own territories. It was clear that both would be under threat if Iran was backed into a corner and started to lash out in all directions. This is exactly what has now happened.

Provided the war doesn’t drag on, it’s sensible to expect that the UAE and others will emerge bruised but not seriously damaged from the confrontation: it takes a lot to shake a rich global entrepot like Dubai. But they will not forget the way that their efforts to intermediate were brushed aside by the US, and there will be good reason to shift more of their financial resources into defence and collaboration with each other. Among other things, that would have implications for global capital markets where they have been important.

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Elsewhere, the war has shifted attention away from Gaza, where the urgent business of reconstruction is on hold and 2 million people are struggling to survive in tents. And it’s hard now to see what might check the progressive annexation of the West Bank. The historian Max Hastings argues that America’s war with Iran has armed Israel to impose almost any sentence it chooses upon the Palestinians.

There will be big political and security consequences for Europe as well. The war in Ukraine has been forced out of the headlines, and its allies are facing new demands for finance and military support elsewhere. Russia, which has expressed strong support for the Iranian regime, looks like a major beneficiary of what’s happening. 

Its financial position, which had appeared to be under threat, is being transformed as the price of oil soars well above the level required to balance the federal budget, estimated at perhaps $60 to $70 a barrel. And the Americans are loosening the grip on where Russian oil can be sold in an effort to hold world prices down, thereby reopening markets which until now had been firmly shut to Vladimir Putin.

Nobody knows what state Iran will be in when the bombing stops. At one extreme lies state collapse of the kind that followed the campaigns in Iraq and Libya. That would have devastating consequences for the region and the world, and could come about from a much prolonged US attack and a fracturing of the IRGC. Both seem unlikely.

At the other extreme lies Trump’s dream scenario in which a strong leader emerges in Teheran willing and able to do a deal with the US – oil in exchange for peace. After a ferocious bombing campaign and decades of mutual hostility, this seems a fantasy – unless the US is willing to move in at ground level to change Iran’s political and economic direction. That would look like nation building, which is a crime in the eyes of the MAGA crowd.

Somewhere in the middle is an Iran that has been seriously diminished yet is still led by a damaged but dangerous regime. Israel continues to attack Hamas in Gaza and Hezbollah in Lebanon. The energy markets have reopened, but the outlook is precarious: closure of the Strait of Hormuz is no longer unthinkable.

It seems there is no good outcome from the war that Trump has started, either for the people of Iran or for the world.

Richard Lambert is former editor of the Financial Times