Markets Wary of Risks to Prevailing Rosy Scenario

World markets are betting a war in Iraq heralds the end of a protracted period of economic and financial uncertainty, but recurring nightmares to this rosy scenario haunt even the optimists.

For now, the money is firmly on a quick, uncomplicated military campaign that will unseat Iraqi President Saddam Hussein within weeks, entail a minimum of civilian and military deaths and retain a framework for global political stability. After months in the doldrums, stocks and the U.S. dollar rallied this week while oil prices and safe-haven government bonds and gold have dropped on signs the conflict is imminent.

But these market moves will be sustained only as long as money managers remain confident a series of risks -- including a bloody siege of Baghdad, torched oilfields, an Iraqi attack on Israel or terrorist attack in the U.S. or UK -- can be avoided.

"The oil market is working on the basis there will be an overwhelming allied victory," said Sydney-based independent oil analyst Simon Games-Thomas as crude fell 10 percent on Tuesday.

But many market experts cautioned against assuming too much, too soon.

"The markets are pricing in the end of the war before it's even started and that carries risks," said Elisabeth Miller of technical analysts Red Tower Research.

What Could Go Wrong

The sheer length of any conflict is crucial and any campaign lasting more than a month without an end in sight is expected to increase market anxiety.

But the top five incidents that were repeatedly cited by financial analysts as most likely to cause a market rethink include the following:

* Iraqi attacks on oilfields in Iraq or elsewhere, leading to prolonged disruption to supplies of crude

* A "Stalingrad-like" siege of Baghdad involving heavy civilian or military casualties, prolonging uncertainty

* An attack on Israel with weapons of mass destruction, risking escalation to the wider region

* Terror attacks on the U.S., UK and their allies by groups opposed to the allied military action in the Middle East

* Civil war in Iraq, leading to an uncontrolled breakup of the country that risks destabilizing the whole region

Indications the war was not going well from the start would spook markets but any relief rally would be vulnerable if Baghdad did not fall within four weeks, said John Davies, fixed income strategist at WestLB in London.

"If you're getting into that fourth week but Saddam Hussein is still in Baghdad and there is no huge progress to resolving the war...that will move the markets back into safe-haven mode."

A long war also poses risks for oil markets.

Oil prices hit a three-month low on Tuesday as Washington's ultimatum to Saddam to leave or face war eased uncertainty. Oil dealers said they expected an easy U.S. victory over the world's seventh largest exporter.

If that does not happen, analysts expect trouble.

"The big question is 'Is he going to blow up his own oil wells, is he going to blow up someone else's?'," said Jim Webber, chief economist for Europe at TD Securities in London.

The Middle East supplies 40 percent of crude exports.

Another major risk is that casualties, especially civilian, begin to mount, possibly in a prolonged siege of Baghdad.

"The worst case has got to be a Stalingrad, Berlin, Grozny scenario," said Nigel Richardson, global investment strategist at AXA Investment Managers.

Civilian casualties could exacerbate the divisions in the international community which some in markets have seen making cooperation on economic problems more difficult.

"On the assumption that it is a short war, high levels of civilian casualties would inflame world opinion against the U.S. and Britain, it would be played on by detractors in the U.N. and Arab nations generally," said Philip Poole, head of emerging markets research at ING.

Any escalation of the war would also disrupt markets. Analysts identify risks including a Kurdish uprising in the north of Iraq, an Iraqi attack on Turkey and, above all, an attack on Israel, possibly with weapons of mass destruction, leading to Israeli reprisals.

"If Israel comes in, they may listen to what the U.S. says for a short while, but they were a hair's breadth from attacking in the last Gulf War," said Jason Simpson, bond strategist at ABN AMRO in London.

He also pinpointed a risk mentioned by several analysts -- that groups such as Usama bin Laden's al Qaeda network retaliate for the strike on Iraq with an attack in Europe or the U.S..

"Bin Laden may rear his head again. He could get his hands on a dirty bomb which could be planted either on European or U.S. soil," Simpson said.

While most of the risks are to the downside, there remains the outside possibility that Saddam quits Iraq in line with Washington's ultimatum and that war is avoided.

"You get regime change without any disruption, without any oil wells being blown up," said a strategist, who asked not to be identified.