Relations between Nasser and the West reached a crisis over plans to finance the Aswan High Dam. Construction of the dam was one of the earliest decisions of the Free Officers. It would increase both electrical generating power and irrigated land area. It would serve industry and agriculture and symbolize the new Egypt. The United States agreed to give Egypt an unconditional loan of US$56 million, and Britain agreed to lend Egypt US$14. The British loan was contingent on the American loan. The World Bank also agreed to lend Egypt an additional US$200 million. The World Bank loan stipulated that Egypt's budget be supervised by World Bank officials. To Nasser these conditions were insulting and were reminiscent of Europe's control over Egypt's finances in the 1870s.

While Nasser admitted to doubts about the West's sincerity, the United States became incensed over Egypt's decision to recognize communist China. Meanwhile, the Soviet Union was offering aid to Egypt in several forms, including a loan to finance the Aswan High Dam. Then, on July 19, the United States withdrew its loan offer, and Britain and the World Bank followed suit. Nasser was returning to Cairo from a meeting with President Tito and Prime Minister Nehru when he heard the news. He was furious and decided to retaliate with an action that shocked the West and made him the hero of the Arabs.

On July 26, 1956, the fourth anniversary of King Faruk's exile, Nasser appeared in Muhammad Ali Square in Alexandria where twenty months earlier an assassin had attempted to kill him. An immense crowd gathered, and he began a three-hour speech from a few notes jotted on the back of an envelope. When Nasser said the code word, "de Lesseps," it was the signal for engineer Mahmud Yunis to begin the takeover of the Suez Canal.

The canal's owner was the Suez Canal Company, an international company with headquarters in Paris. Anthony Eden, then British prime minister, called the nationalization of the canal "theft," and United States secretary of state Dulles said Nasser would have to be made to "disgorge" it. The French and British depended heavily on the canal for transporting oil supplies, and they felt that Nasser had become a threat to their remaining interests in the Middle East and Africa. Eden wanted to launch a military action immediately but was informed that Britain was not in a position to do so. Both France and Britain froze Egyptian assets in their countries and increased their military preparedness in the eastern Mediterranean.

Egypt promised to compensate the stockholders of the Suez Canal Company and to guarantee right of access to all ships, so it was difficult for the French and British to rally international support to regain the canal by force. The Soviet Union, its East European allies, and Third World countries generally supported Egypt. The United States moved farther away from Britain and stated that while it opposed the nationalization of the canal, it was against the use of force.

What followed was the invasion of Egypt by Britain, France, and Israel, an action known as the Tripartite Invasion or the 1956 War. Whereas the truth about the invasion eventually became known, at the time the Conservative government in London denied that it used Israel as an excuse for attacking Egypt. Eden, who had an intense personal dislike for Nasser, concealed the cooperation with Israel from his colleagues, British diplomats, and the United States.

The plan, which was supposed to enable Britain and France to gain physical control of the canal, called for Israel to attack across the Sinai Desert. When Israel neared the canal, Britain and France would issue an ultimatum for an Egyptian and Israeli withdrawal from both sides of the canal. An Anglo-French force would then occupy the canal to prevent further fighting and to keep it open to shipping. Israeli prime minister David Ben-Gurion agreed to the plan but informed Britain that Israel would not attack unless Britain and France first destroyed the Egyptian air force.

On October 28, Israeli troops crossed the frontier into the Sinai Peninsula (also seen as Sinai), allegedly to destroy the bases of Egyptian commandos. The first sign of collusion between Israel and Britain and France came on the same day when the Anglo-French ultimatum was handed to Egypt and Israel before Israel had even reached the canal. British bombing destroyed the Egyptian air force, and British and French paratroopers were dropped over Port Said and Port Fuad. The Egyptians put up fierce resistance. Ships were sunk in the canal to prevent transit. In the battle for Port Said, about 2,700 Egyptian civilians and soldiers were killed or wounded.

Although it was invaded and occupied for a time, Egypt can claim to have emerged the victor. There was almost universal condemnation of the Tripartite Invasion. The Soviet Union threatened Britain and France with a rocket attack if they did not withdraw. The United States, angered because it had not been informed by its allies of the invasion, realized it could not allow the Soviet Union to appear as the champion of the Third World against Western imperialism. Thus, the United States put pressure on the British and French to withdraw. Faced with almost total opposition to the invasion, the anger of the United States, and the threat of the collapse of the pound sterling, the British agreed to withdraw. Severely condemned, Britain and France accepted a cease-fire on November 6, as their troops were poised to advance the length of the canal. The final evacuation took place on December 22.

Israel, which occupied all of Sinai, was reluctant to withdraw. President Dwight D. Eisenhower of the United States placed great pressure on Israel to give up all its territorial acquisitions and even threatened sanctions. The Israelis did withdraw from Sinai, but they carried out a scorched earth policy, destroying roads, railroads, and military installations as they went.

A United Nations Emergency Force (UNEF) was established and began arriving in Egypt on November 21. The troops were stationed on the Egyptian side of the Egyptian-Israeli border as well as along the eastern coast of Sinai. Israel refused to allow UN troops on its territory. The UN troops were stationed on the Gulf of Aqaba to ensure the free passage of Israeli shipping to Elat. The troops remained in Egypt until 1967, when their removal contributed to the outbreak of the June 1967 War.

Egypt reopened the canal to shipping in April and ran it smoothly. It was open to all ships except those of Israel, and it remained open until the June 1967 War (Arab-Israeli war, also known as the Six-Day War). Diplomatic relations between Egypt and Britain were not restored until 1969.

Nasser had won a significant victory. The immediate effect was that Britain and France were finally out of Egypt. Nasser went on to nationalize all other British and French assets in Egypt. The Egyptians now had full control of the canal and its revenues. The Suez crisis also made Nasser the hero of the Arab world, a man who had stood up to Western imperialism and had prevailed.