March 29, 2010
If Israel were to strike Iran over its nuclear activities, markets would be watching one thing only -- Iran's response.
The scale of that response could be the difference between a brief spike in oil prices and pushing the world back to economic crisis.
Below are possible scenarios together with projected potential market reactions suggested by analysts, economists and foreign policy strategists.
NO IMMEDIATE REACTION
Tehran announces that Israel's military attacked civilian locations but inflicted little damage. It hurls furious rhetoric at Israel but stops short of any military response.
"It may make sense for the Iranians to play the victim," said IHS Global Insight Middle East analyst Gala Riani. "They may also use it to build the regime's legitimacy internally."-- news of the strike would see oil prices spike $10-$20 and wider investor flight to safer assets such as U.S. treasuries, while equities and risky currencies would suffer. But without further action, sentiment would recover.
-- relatively used to conflict, Israeli markets might prove more resilient to the initial news. Some analysts suggest that a successful strike that significantly put back an Iranian nuclear program could be positive for Israeli markets.
-- assessing the effectiveness of an attack on Iranian facilities could prove almost impossible. The longer-term impact of the strikes on Iran's internal politics, regional politics and Western support for Israel would be hard to predict.
-- can Israel achieve its aims with a single strike, or would it require a more sustained operation potentially lasting several days and hitting markets much harder?
Iran steers clear of any overt response, but backs intensifying attacks by Hamas from the Palestinian territories and by Hezbollah from Lebanon. It might also back proxy attacks on Western forces in Iraq and Afghanistan.
"The most likely response would be to increase their subversive activity across the Middle East," said IHS's Riani. "It would most likely be focused in Palestine, Lebanon and to a lesser extent around the Gulf."-- might have some short-term impact on oil prices -- particularly if the attacks included Iraq -- but generally global markets would be little affected.
-- Israeli markets would likely take initial attacks in their stride, but a prolonged campaign would drag on the economy, driving up defense spending and undermining markets as they did during the Palestinian Intifada.
-- the duration of increased violence. Proxy violence could escalate to include militant attacks on Western and oil targets.
-- If Hezbollah strikes Israel, Israel will retaliate in a way that quickly expands the conflict. Israel has threatened to hold the governments of Lebanon and Syria responsible for any Hezbollah attacks.
MISSILES STRIKE ISRAEL
Iran retaliates by launching ballistic missiles with conventional warheads. While more accurate than the Scuds launched by Iraqi leader Saddam Hussein at Israel during the 1991 Gulf War, damage from each strike would be limited.
"It's certainly not something you can rule out," said Metsa Rahimi, intelligence analyst for risk consultancy Janusian. "The Iranians are going to want to retaliate. But they know if they do this, they are going to get hit back again."-- oil prices would certainly spike higher, although attacks on Israeli cities would not directly have any impact on oil production. Wider global markets would sell off and watch nervously for any further escalation.
-- Israeli markets might again prove more resilient. They actually rallied in January 1991 during the missile attacks as it became clear the strikes were not chemical and not causing significant damage. Much would depend on the level of damage and for how long any missile barrage continued.
-- Israeli and Western reaction. Would there be further retaliation? Would weapons used remain conventional?
-- Would Israel strike military targets and civilian infrastructure in Iran, possibly including oil facilities? That would push-up prices and force primary customer China to look for supplies elsewhere.
Iran makes good its threat to close the Straits of Hormuz to traffic, blocking the flow of some 17 million barrels a day of oil, roughly 40 percent of all seaborne oil trade -- but likely inviting swift retaliation from United States forces.
"Iran doesn't even need to be successful in their threat," said Michael Wittner, global head of energy research at Societe Generale. "Even a credible threat or near miss and insurance rates will spike. Then no one's going to send any oil through there for a couple of weeks until somebody's navy can re-establish control."-- analysts estimate this could push oil prices up toward $150 a barrel. Alternative oil producers such as Russia, Nigeria and Angola might benefit, but rising fuel costs would likely undercut growth everywhere. China, Iran's main export destination, would have to seek supplies elsewhere.
-- Other financial markets would suffer and fall sharply if they believed disruption would be long term.
-- Israeli markets are likely to be affected by the wider frenzy, although probably less than volatile emerging markets.
-- how long could Iran maintain its blockade? Military analysts believe its handful of mine-laying ships, helicopters and submarines might quickly be neutralized by the US military.
SPARKING WIDER CONFLICT
Ultimately, the consequences of an Israeli strike on Iran are hard to predict. At worst, it could fuel an upsurge in wider regional violence.
"I worry a great deal about the unintended consequences of a strike," Chairman of the US Joint Chiefs of Staff Admiral Mike Mullen said on a recent visit to Israel.-- a more violent Middle East would put an inherently higher risk premium on oil, pushing up prices and possibly undermining global recovery from the financial crisis. It might also drive consuming nations toward non-Middle Eastern suppliers and alternative technologies.
-- investors would also view Israel as much higher risk, while much higher defense spending would weigh on the economy.
-- duration and severity of any conflict. Would the world's wider powers -- China, Russia, the United States and European Union in particular -- move toward a consensus on the Middle East or would the conflict exacerbate their differences further?