By Kit Rees
LONDON (Reuters) - Crude oil prices hit 3-1/2-year highs on Wednesday after President Donald Trump pulled the United States out of an international nuclear deal with Iran, while the dollar touched a new high for the year and world stocks held steady.
Trump's move sparked fears of increased tension in the Middle East and uncertainty over global oil supplies.
Demand for safe-haven assets remained muted as the immediate market impact was seen as specific to oil supply, but investors remained mindful of the knock-on effects on inflation.
Gold prices retreated and bond yields rose. The U.S. 10-year Treasury once again breached the psychologically significant 3-percent level and hit a two-week high of 3.0140 percent, supported by expectations of higher interest rates.
"In an environment where the Fed, particularly, is already at its inflation target and people are closely watching the pace of the monetary tightening, something like this which could possibly nudge inflation a little bit higher is going to be quite interesting for the market," UBS Wealth Management's UK chief investment office deputy head, Caroline Simmons, said.
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"That's why you're seeing the yields go up a little bit on the bonds," she said.
The impact of Trump's decision was mostly limited to oil markets and energy-related stocks. West Texas Intermediate crude futures hit their highest level since November 2014 at $71.17 per barrel, last up 2.7 percent.
Brent crude futures jumped as much as 2.8 percent to a 3-1/2-year high of $77.20.
"There is still an interim period before sanctions kick in. And other signatories and Iran want to keep the deal going so there is a period where things could be hammered out," ING rates strategist Benjamin Schroeder said.
"But I would have expected a bit of a safe-haven bid this morning," he noted, referring to bonds.
The MSCI world equity index, which tracks shares in 47 countries, was flat and continued to trade in a narrow range. The pan-European STOXX 600 meanwhile rose 0.2 percent as oil majors gained and earnings from Siemens and Imperial Brands dominated trading.
In the U.S., stocks futures pointed to a positive start for Wall Street, with E-Mini futures for the S&P 500 up 0.5 percent.
"In the very short term, it looks as if the impact of heightened geopolitical worries was limited to oil markets. But that is not the end of the story," Mitsubishi UFJ Morgan Stanley Securities senior investment strategist Norihiro Fujito said.
"U.S. sanctions could affect various industries. And tensions between Iran and Israel look set to intensify. Those will begin to cap share prices," he said.
The reaction in Asian markets was more pronounced as renewed U.S. sanctions on Tehran were seen as disruptive for many companies that have dealings with Iran. Trump's move is also seen as likely to worsen already-tense relations between Iran and U.S. allies in the region.
MSCI's broadest index of Asia-Pacific shares outside Japan was up 0.1 percent, while Japan's Nikkei fell 0.4 percent.
Iran, the third-biggest OPEC producer, produces about 3.8 million barrels per day (bpd), or about 4 percent of the world's oil supplies.
The U.S. Treasury said it will reimpose a wide array of Iran-related sanctions after the expiry of 90- and 180-day wind-down periods, including those aimed at Iran's oil sector and transactions with its central bank.
DOLLAR STEPS BACK FROM HIGH
The rise in Treasury yields helped fuel the dollar's rally, with the greenback hitting a new 2018 high before giving up gains.
The dollar index against a basket of major currencies was at 93.026. It has risen about 1 percent this year.
Souring risk sentiment is hitting emerging markets, which have been depressed in recent weeks by concerns about capital outflows, as the prospect of higher U.S. interest rates lures investors back to U.S. bonds rather than riskier assets.
Countries with high perceived political risks, such as Brazil and Turkey, were among the worst hit.
The Brazilian real hit a near two-year low and the Turkish lira reached a record low. Since the start of this week, those currencies are both down about 1 percent.
The Indonesian rupiah hit a 2-1/2-year low, and has slid 1 percent this week.
Among major currencies, the risk-sensitive Australian dollar hit an 11-month low of $0.74130 and last stood at $0.74510.
The euro recovered slightly after hitting a new 4-1/2-month low of $1.1821 and last stood at $1.1880, having fallen about 4 percent in the past three weeks.
The currency was hit by increasing prospects of another election in Italy as the political impasse there has continued since early March's vote.
The British pound was slightly firmer at $1.3538 but remained close to a four-month low ahead of the Bank of England's meeting on Thursday.
The dollar rose 0.5 percent to 109.65 yen, edging near its three-month high of 110.02 yen touched last week.
(Reporting by Kit Rees Additional reporting by Dhara Ranasinghe in London and Hideyuki Sano in Tokyo)