Investors worry that the war in the Middle East could lead to inflationary pressure and tighter monetary policy. For now, the dollar is benefiting from its safe haven status
Oil and gas prices are already spiking after the US and Israel’s attacks on Iran. A conflict that persists for months could undermine global growth forecasts and create exchange rate volatility.
Investors chose the dollar over sterling and the euro last week as they sought safe haven assets amidst escalating conflict in the Middle East. While the European currencies clawed back a little value in the last session on Friday, the euro lost over 2.4% of its value against the dollar over the week as a whole, while the pound slipped by over 2.1% against its US counterpart.
Markets are concerned by Europe’s reliance on Middle Eastern oil. The war has already created a surge in oil and gas prices that could lead to inflationary pressure and monetary tightening if conflict continues indefinitely. On Friday, the International Monetary Fund said a 10% increase in energy prices that last for 12 months would push up global inflation by 40 basis points. Rising inflation could limit the likelihood of rate cuts in the US and Europe and lead to money market volatility.
The chances of rate cuts fall
The immediate impact of the war can be seen in money market expectations of interest rate cuts. Before the conflict started, investors had an 80% expectation of a cut in UK interest rates this month. That figure now stands at 20%. At 2.15%, rates are already significantly lower in the eurozone, where money markets now see a 55% chance of a rate hike in July as inflationary pressures mount.
The week ahead
The war in the Middle East will continue to dominate sentiment this week. Investors will be looking for signs of either further escalation or a scaling back of hostilities and any possible reopening of the strategically important Strait of Hormuz.
- Monday: Trade balance from Germany & France
- Wednesday: US inflation data
- Friday: US & UK GDP
