He made the warning during a tour of South-East Asia in which he is meeting leaders to discuss Iraq, terrorism and the continuing crisis over North Korea's resumed nuclear programme.
"
If he [Saddam Hussein] continues to get away with it, other would-be proliferators will take heart and the world will become a far more dangerous place
"
Jack Straw
Foreign Secretary
Mr Straw, stressing that action against Iraq is not action against Islam, called for greater understanding between faiths as a "fitting tribute" to the victims of the Bali bombing.
But religious leaders who heard the speech were unanimous in their opposition to any attack on Iraq.
The speech in the Indonesian capital Jakarta on Thursday comes on a two-day trip to the country.
The foreign secretary was also scheduled to meet his counterpart, Hassan Wirayuda, and hold talks with President Megawati Sukarnoputri.
War fears
During his address Mr Straw stressed British support for a Middle East peace process.
But setting out his key message, he said: "The consequences of a failure of nerve to deal with the threat by Iraq's weapons of mass destruction are potentially devastating for Muslims and non-Muslims alike."
The prospect of war with Iraq concerns people in both Britain and Indonesia, but that should not stop Iraqi leader Saddam Hussein from being disarmed peacefully or by force, Mr Straw said.
"If he continues to get away with it, other would-be proliferators will take heart and the world will become a far more dangerous place," the foreign secretary added.
Mr Straw arrived in Indonesia after three days in Singapore, and will next visit Malaysia.
Bombings legacy
Authorities in South-East Asia have been on a state of alert since 192 people - including 26 Britons - were killed in the Bali bombings in Indonesia in October.
Mr Straw said that if governments are to "establish a fitting memorial to the victims of the Bali tragedy and strengthen global security" they must do more "than simply mete out justice to the terrorists".
"We will have to tackle the mistrust and misapprehensions which bedevil relations between the West and the Islamic world and which in turn allow the terrorists to secure new recruits for their twisted cause.
"The promotion of peace and reconciliation between all faiths must therefore become an objective of politicians and religious leaders alike."
Religious response
Religious leaders gave Mr Straw a polite hearing but speakers at a question and answer session following the speech were unanimous in their opposition to any attack on Iraq.
Ahmad Syafii Maarif, chairman of Indonesia's second largest Muslim organization Muhammadiyah, said attacking Iraq and ousting Saddam would be tantamount to "state terrorism."
Another Muslim leader, Nurcholis Madjid, said a war on Iraq would "destabilise the world and legitimise the radicals" in Indonesia.
Christian leader Cardinal Julius Darmaatmaja said using war to achieve peace was "more or less ironic."