With no signs of de-escalation and the Strait of Hormuz closed to most shipping, money markets are betting on the dollar
The conflict in the Middle East continues to reverse gains made by the euro and pound against their US counterpart over the last year. With no end to the war currently in sight, volatility is expected to continue.
The dollar continued to strengthen against the euro and pound last week as rockets and drones rained down on targets across the Middle East. The fear that the war is getting out of hand is driving the dollar’s safe haven status, with the euro hitting its weakest level against its US counterpart since last summer. The pound is also trending downwards, hitting its lowest level against the dollar in four months, though both European currencies steadied during early trading on Monday.
While the dollar is benefitting from safe haven status, the European currencies are struggling because of the region’s heavy dependence on oil from the Middle East. Rising energy costs are impacting the euro, which has now lost over 3.6% of its value against the dollar in the last month. The pound faced a double whammy last week, with geopolitical tensions and worse-than-expected UK GDP figures for January combining to undermine investor confidence
The Iran war could drive interest rate rises
The war is driving up energy prices which in turn causes inflationary pressures. Central banks usually turn to interest rates to control prices, which is why money markets now expect two rate hikes from the European Central Bank (ECB) this year. Before the war, with inflation in the eurozone at a below target 1.7%, no rate increases seemed likely. In the UK, where rates are currently 3.75%, the Bank of England (BoE) will be under pressure to keep rates higher for longer, or even tighten policy if inflationary pressures persist beyond the Spring.
The week ahead
All eyes will inevitably be on the Middle East, looking for any signs of de-escalation in the conflict or a readiness on the part of both sides to negotiate. President Trump has vowed to reopen the Strait of Hormuz with the help of allies but that possibility seems remote at present. Investors will also be closely monitoring interest rate decisions this week from the US Federal Reserve (Wednesday), the ECB and the BoE (both Thursday). The numbers will be important, but markets will also analyse policy statements in detail for any hints of how central banks hope to protect economies from the impact of escalating oil and gas prices.
- Wednesday: US Federal Reserve – interest rate decision
- Thursday: UK – Bank of England (BoE) & European Central Bank (ECB) – interest rate decisions
