By Fiona Shaikh and Arshad Mohammed
LONDON/WASHINGTON (Reuters) - Britain ordered its financial institutions on Monday to halt all business with Iranian counterparts, including the central bank, and the United States is also expected to tighten sanctions over Tehran's nuclear program.
The British move however will not target trade in Iranian oil, a source familiar with the sanctions said. It also appeared unlikely that the U.S. Treasury would try to cut off the Iranian banking system entirely, a move that could disrupt global energy markets and harm the U.S. economic recovery.
Britain said the sanctions were in response to the International Atomic Energy Agency's (IAEA) latest report on Iran, which highlighted fresh concerns about the possible military dimensions of Tehran's nuclear program.
"We believe that the Iranian regime's actions pose a significant threat to the UK's national security and the international community. Today's announcement is a further step to preventing the Iranian regime from acquiring nuclear weapons," said finance minister George Osborne.
In Washington, a U.S. official said the Treasury Department planned to designate Iran as an area of "primary money laundering concern" on Monday, a move allowing it to take steps to isolate the Iranian financial sector further.
Henry Smith, Middle East analyst at the Control Risks consultancy in London, said the British move may not significantly affect Iran's major oil customers.
"It essentially delegitimizes the country's financial system but in reality it may not make that much practical difference. The Chinese, Indians and others will continue to engage, while many Western multinationals have already pulled out," he said.
Smith said tighter sanctions had appeared more likely than any Western attack to knock out Iran's nuclear facilities. "We wouldn't regard Israel or indeed the U.S. as having the wherewithal to pursue the kind of military action required to destroy Iranian nuclear facilities," he said.
U.S. sanctions have already made it extremely difficult for many global oil companies and traders to obtain bank financing to trade Iranian crude, of which less than a third goes to Europe with the rest flowing to China and India.
The Wall Street Journal reported earlier that the U.S. Treasury would not formally sanction Iran's central bank, in part to avoid causing a sudden shock to oil prices.
It was unclear what exact steps the U.S. Treasury planned. However, the decision, which the official said was to be announced by Secretary of State Hillary Clinton and Treasury Secretary Timothy Geithner, appeared designed as a warning about the risks of dealing with Iran's financial institutions.
It follows a November 8 report by the U.N. nuclear watchdog that presented intelligence suggesting that Iran had worked on designing an atomic bomb and may still be secretly carrying out related research.
The U.S. administration suspects Iran is pursuing a nuclear weapons capability under cover of its civilian atomic energy program. Tehran denies this, saying it has no interest in nuclear arms and its atomic program is purely peaceful.
In Tehran, trade minister Mehdi Ghazanfari said sanctions were hitting the Iranian economy but warned Western countries threatening to tighten the measures they were harming their own interests.
"Sanctions are a lose-lose game in which both sides make a loss. If they don't invest in our oil projects, they will lose an appealing market," Ghazanfari told a news conference before the British announcement.
The comments from Ghazanfari, who is Minister of Industry, Mine and Commerce, marked a change of tone from Tehran's usual line that sanctions have not damaged the economy.
The United States is also expected to unveil sanctions against Iran's petrochemical sector on Monday, sources familiar with the matter said on Friday.
President Mahmoud Ahmadinejad has often said sanctions are having little effect on the economy and in some cases have made it stronger by making Iran find domestic solutions to economic challenges.
Ghazanfari reiterated the stance that Iran had found alternatives to Western imports and investments, but did not deny the downside.
"Facing hardship in a fight is inevitable. I admit projects will get harder as our trading costs will go up, delays will hit projects and money transfer will get harder," he said.
U.S. officials say there has been a debate within the Obama administration about whether to sanction formally the Iranian central bank, which many importers of Iranian crude oil use to clear their transactions.
Despite calls for such sanctions by Democratic and Republican lawmakers, U.S. officials have been reluctant to do so because of the fear that this could cause oil prices to jump, potentially impairing the U.S. economic recovery.
There is also a concern that importers of Iranian oil, including China and India, could be hurt by such a move, thereby antagonizing nations whose support Washington needs if it is to pursue wider sanctions on Iran.
The U.S. decision to take unilateral steps to sanction Iran reflects the difficulty of persuading Russia and China to punish Tehran further at the U.N. Security Council, where they hold vetoes and have supported four previous sanctions resolutions.
Several European firms including Italy's Eni, France's Total, Greece's Hellenic and Royal Dutch Shell are still trading Iranian crude often as part of long-standing credit and other agreements.
Traders with several companies said they would need to see the new terms before taking any decision. "I will need to speak to my risk and finance department," one trader said.
(Additional reporting by Peter Apps and Dmitry Zhdannikov in London and Ramin Mostafavi in Tehran; writing by David Stamp)