President Barack Obama signed new sanctions against Iran into law on Saturday, shortly after Iran signaled it was ready for fresh talks with the West on its nuclear program and said it had delayed long-range missile tests in the Gulf.
Tensions between Iran and the West have grown since EU leaders said they wanted to set tougher sanctions against Tehran by the end of next month in a bid to force it to curb a research program that they suspect is developing nuclear weapons.
In the absence of a fresh mandate from the U.N. Security Council, which has already imposed four rounds of global sanctions, Washington has also stepped up the pressure with sanctions on financial institutions that deal with Iran's central bank.
The defense funding bill, approved by Congress last week, aims to reduce the oil revenues that make up the bulk of Iran's export earnings. Obama signed it in Hawaii, where he was spending the Christmas holiday.
If enforced strictly, the sanctions could make it nearly impossible for most refiners to buy crude from Iran, the world's fourth biggest producer.
However, Obama asked for scope to apply the measures flexibly, and will have discretion to waive penalties. Senior U.S. officials said Washington was consulting foreign partners to ensure the new measures did not harm global energy markets.
Iran makes threats
Iran responded to the growing pressure by warning this week that it could shut the Strait of Hormuz if sanctions were imposed on its oil exports. It launched 10 days of naval wargames in the Gulf as a show of strength, further rattling oil markets and pushing up the price of crude.
In the past, Iran has threatened to close the waterway only if attacked by the United States and Israel.
The U.S. Fifth Fleet, based in Bahrain, said it would not allow shipping to be disrupted in a waterway through which 40 percent of the world's oil passes.
Analysts say that Iran is playing for time and that its increasingly strident rhetoric shows its clerical leadership is concerned about even harsher penalties.
Against this backdrop, Iran's state media reported early on Saturday that long-range missiles had been launched during the naval exercises.
But Deputy Navy Commander Mahmoud Mousavi later went on the English language Press TV channel to deny they had in fact been fired: "The exercise of launching missiles will be carried out in the coming days."
Separately, Iranian media reported that nuclear negotiator Saeed Jalili would write to the EU foreign policy chief to say Iran was ready for fresh talks on its nuclear program, which it says is aimed exclusively at power generation.
"Jalili will soon send a letter to Catherine Ashton over the format of negotiations ... then fresh talks will take place with major powers," the semi-official Mehr news agency quoted Iran's ambassador to Germany, Alireza Sheikh Attar, as saying.
Negotiations between Iran and the five permanent members of the U.N. Security Council - the United States, Russia, China, Britain and France - plus Germany (P5+1) stalled in January.
Ashton, leading the European negotiators, wrote to Jalili in October and has not yet had a reply, her spokesman Michael Mann said. But the bloc was open to meaningful talks with Tehran:
"We continue to pursue our twin-track approach and are open for meaningful discussions on confidence-building measures, without preconditions from the Iranian side."
A U.S. administration official added: "We have indicated for years that we are willing to engage in talks with Iran, provided it is ready to engage in a meaningful and constructive fashion." Senior officials said the sanctions did not alter this policy.
Iranian analyst Hamid Farahvashian said Tehran was seeking to send a message to the West that it should think twice about the economic cost of putting pressure on Iran.
"The Iranians have always used this method of carrot and stick ... first they used the stick of closing Hormuz and now the carrot is their willingness for talks," said Farahvashian.
Talks between Iran and the P5+1 have been stalled for a year and Malcolm Chalmers, Research Director at the Royal United Services Institute think tank in London, said Europe would be skeptical about the offer.
"EU countries will be wary of yet another attempt by Iran to play for time, seeking to postpone sanctions simply because talks have resumed," he said.
"So Iran will have to offer significant concessions even to get a conversation started on slowing the implementation of sanctions. And, all the time, the Europeans are aware of the growing war talk in Washington, where the pressure on (U.S. President Barack) Obama to launch an 'October surprise' to clinch the (U.S. presidential) election seems to be growing."
The United States and Israel have not ruled out a military option if diplomacy fails to resolve the nuclear dispute.
A senior Western diplomat in Tehran, who asked not to be named, said the fact that the Iranians were stepping up their threats "shows that they are worried about losing petrodollars, on which more than 60 percent of the economy depends."
The Iranian threat briefly pushed benchmark Brent crude up by more than a dollar to over $109 a barrel this week.
Oil Minister Rostam Qasemi told Saturday's weekly Aseman that further sanctions would push oil over $200 a barrel.
Sanctions take toll
Chalmers said sanctions were most effective in influencing behavior when they were imminent and credible but not yet in place as, once in place, they were hard to lift, short of a comprehensive conflict resolution.
"The Iranians know this, and are seriously worried by the prospect of an EU oil embargo, especially as it could be followed by action by the U.S.'s close Asian allies," he said.
"They could then be left at the mercy of China and India, who are likely to demand big price discounts in order to shift purchases from Arab countries, who will not be happy, to Iran."
The rising tensions are having an impact at home. Iran's currency has nosedived in recent weeks as ordinary Iranians have moved money from savings accounts into gold or foreign currency.
The price of staple foods has increased by up to 40 percent in recent months and many critics have put the blame on increasing isolation brought about by President Mahmoud Ahmadinejad's economic and foreign policies.
Iran's massive media coverage of the naval maneuvers appeared an attempt by the authorities to strike a patriotic chord among ordinary Iranians worried about a military strike.
"I have already witnessed a war with Iraq in the 1980s ... I can hear the drumbeat of war," said merchant Mohsen Sanaie, 62, glancing over newspaper headlines at a central Tehran newsstand. "One stray bullet could spark a war."