The economic impact of the Middle East conflict is beginning to bite, with potentially significant consequences for money markets
The dollar continued to strengthen last week as confusion reigned over the conflict in the Middle East and strong US jobs data undermined hopes of US interest rate cuts. The pound traded at levels not seen since last autumn against the dollar, while the euro continued to lose some of the value accumulated over the previous 12 months. The euro remains up over 5.8% against the dollar in the last year, but has weakened by nearly 0.8% in the last month.
The situation in the Middle East remains highly volatile, with talks of a potential ceasefire plan clashing with President Trump’s renewed threats to bomb Iranian infrastructure. The deadline Trump has set for Iran to reopen the strait of Hormuz will pass late on Tuesday. Money market volatility may be expected if the conflict enters a new and even deadlier phase.
Uncertainty reigns in Europe
The conflict in the Middle East has blown away earlier economic forecasts for the eurozone and the UK for 2026 and beyond. At the moment, the European Central Bank’s (ECB) baseline projection would see inflation rise to 2.6% in the eurozone and growth fall to 0.9% this year. In this scenario, which may already be looking optimistic, the ECB would likely turn to interest rate hikes to suppress inflation, at the risk of further suppressing growth. Analysts also expect the Bank of England (BoE) to use interest rate rises as an anti-inflationary measure sooner rather than later. A rate hike by the summer can’t be ruled out.
Interest rate movements have a significant impact on exchange rates, because they make currencies more or less attractive to investors.
The week ahead
What happens after the passing of Trump’s Tuesday deadline for the opening of the strait of Hormuz will be the focus of the next couple of days. This week will also see the release of PMIs (snapshots of economic activity taken from business leader surveys) across the the eurozone and UK (Tuesday). This data will shed light on the early impacts of the Iran war on business confidence. GDP and inflation figures in the US will be the main data points on Thursday and Friday respectively.
