The greenback continued to rally against every other major currency last week as the Iran war shows no signs of ending any time soon. European currencies are the worst performers, as markets worry about their dependence on energy imports amid the ongoing blockage of the Strait of Hormuz and the subsequent rally in oil futures, which are now back above $100 a barrel. While risk assets look wobbly, US stocks have only fallen to the levels of three months ago. Government bonds everywhere continue to underperform and most investors in the asset class are nursing losses so far this year amid fears over higher inflation globally.
Markets will remain fixated on the news from the Iran war this week, particularly any attempts made by the US to restart the flow of vessels through Hormuz. We also have a rare confluence, whereby the Federal Reserve, Bank of England and ECB will also meet within 24 hours on Wednesday and Thursday. There will be no change in rates, with the primary focus to instead be on how policymakers assess the implications of the spike in oil prices and the aggressive hawkish repricing in interest rate expectations. We think that all three will attempt to stay as non-committal as possible at this stage.
GBP
Sterling continues to outperform the euro, having fallen only half as much as the common currency relative to the dollar since the Iran war began. This partly reflects the fact that the British economy is relatively less exposed to international energy prices than the Eurozone, and the more aggressive upward repricing in Bank of England interest rates relative to the ECB. Last week’s monthly GDP print for January was a clear disappointment (flat growth versus the +0.2% estimate), although this was both overshadowed by the Iran war news and overlooked given that this data point tends to be highly volatile and unpredictable.
This week looks to be particularly critical for the pound. The Bank of England meeting on Thursday is the main focus, in particular the MPC’s reaction to the prospect of sharply higher energy prices and market assumptions that the bank is done cutting. While swaps are now pricing in a hike later in the year, we think that this may be slightly premature given that it is not yet clear whether the spike in energy prices will be enough to induce second-round effects or materially de-anchor inflation expectations. A slate of key labour market data will precede the meeting on Thursday morning.
EUR
The common currency has dropped towards the 1.14 level on the US dollar in response to not only expectations that the Iran war will drag on for weeks to come, but that the Strait of Hormuz will remain effectively impassable for much longer than anticipated. Interestingly, the Iran war, and the subsequent spike in oil prices, have caused among the sharpest divergences that we’ve seen between market pricing and economists' expectations for rates in a number of years. Traders are now pricing in almost two full rate hikes from the ECB during the remainder of 2026, while very few strategists expect even one.
Communications from the European Central Bank at its meeting on Thursday will be particularly delicate. Market participants will be hoping that Lagarde clarifies which narrative is correct, and sheds light on the bank’s reaction to the prospect of another energy price spike while growth remains subdued, and German data continues to disappoint. A handful of ECB officials struck surprisingly hawkish notes during their remarks last week, and it will be interesting to see whether Lagarde follows suit. While we expect her to touch on the potential inflationary implications of the conflict, we doubt that she will provide clear guidance until members have greater clarity on the length of the Iran conflict.
USD
The flight to safety bid means that the dollar has ignored recent weak macroeconomic data out of the US over the last couple of weeks. It's notable that the greenback continues to rally even as the Federal Reserve is just about the only major central bank still expected to cut rates this year, rather than raise them, which can be largely attributed to America’s standing as a net exporter of oil, rather than an importer. This makes the Fed meeting on Wednesday just as critical as those of other central banks this week, particularly as markets are starved for guidance from central bankers generally as to how they may respond to the war.
We think that Chair Powell will do his level best to indicate to markets that the FOMC is in a “wait and see” mode, although he may hint that the uncertainty and spike in energy costs associated with the geopolitical flare-up could delay the path of US cuts. Given that the US is a net exporter of oil, higher oil prices are both a boost to real GDP growth and not overly inflationary. With the US labour market also weakening, our base case remains for Fed cuts. Given that the US is a net exporter of oil, higher oil prices are both a boost to real GDP growth and not overly inflationary. With the US labour market also weakening, our base case remains for Fed cuts to resume later in the year, although Powell will not firmly commit to that at this stage.
Deep dives and expert insights:
- G10 currency market report - Get the latest analysis on major currencies.
- FX Talk - Iran war fallout (with Simon French)
