The US-Iran war is creating inflationary pressures that may push up interest rates before the year is out
It was a bruising week for economies on both sides of the Atlantic as the US-Iran war took its toll on consumer and business confidence. In the US, consumer sentiment is at its weakest on record, according to the influential University of Michigan Consumer Sentiment Index. On the other side of the pond, German business confidence plummeted to a six-year low. The fear is that things might get worse before they get better, after President Trump cancelled his envoys’ trip to Pakistan for peace talks.
The euro strengthened against the dollar by around 1.15% between 1 April and 25 April. The pound has also shown resilience, strengthening against the dollar by over 2% in the same time frame. This compares to declines for both European currencies in the previous month and reflects hopes that the ceasefire in the Middle East will continue, even as peace talks stall.
Interest rate expectations buoy pound
Higher interest rates signal better returns for currency investors, so signs of mounting inflationary pressure in the UK are helping to strengthen sterling. After inflation jumped to 3.3% in March (up from 3% in February), Bank of England (BoE) data suggest 64% of UK businesses expect to have to raise prices over the next 12 months. With inflation on an upward trajectory, money markets now price in two quarter point rate hikes in 2026, with the possibility of a third.
Investors expect a similar response from the European Central Bank (ECB), with two or three rate increases before the end of the year. In the US, markets now expect a “higher for longer” interest rate strategy from the Federal Reserve (Fed), and see less chance of the hefty rate cuts favoured by President Trump.
The week ahead
Hopes for peace talks in the ongoing US-Iran conflict were dashed at the weekend but markets will be looking for more positive news in the coming days. In addition, they will be focused on interest rate decisions in the US (Wednesday) and UK (Thursday) – most experts think rates will be left unchanged at 3.75% in both countries. The ECB interest rate decision (Thursday) is also likely to see rates unchanged, though eurozone interest rates are much lower at 2.15%. Central banks are taking a “wait and see” stance on rates for the moment, but more hawkish sentiment may come to dominate later in the year.
