Pound Falls as Dollar Strengthens on Middle East Risks

Key Moments

Market Overview

GBP/USD remains under pressure in early European trading on Monday, hovering around 1.3390 after recovering part of its intraday decline. The pair continues to struggle as the US Dollar (USD) advances on the back of safe-haven flows and renewed geopolitical tensions in the Middle East.

The British Pound (GBP) is finding some support from longer-term interest rate expectations, but near-term sentiment is being dictated by global risk aversion and the outlook for US monetary policy.

Geopolitical Tensions Support the US Dollar

Safe-haven demand for the USD has intensified after US Central Command (CENTCOM) extended its military campaign against Iranian targets. On Sunday evening, CENTCOM carried out further airstrikes, adding to a three-night series that has already hit more than 300 Iranian targets, including 140 on Saturday.

According to the report, the stated objective of these strikes is to weaken Iran’s capacity to attack civilian vessels passing through key maritime routes. The escalation has led Washington and Tehran to issue conflicting statements about whether the strategic strait remains open to commercial shipping, increasing uncertainty for global markets.

Inflation Concerns and Fed Outlook

The US Dollar is also drawing support from higher oil prices, which are stirring fresh worries about inflation and the possibility that the Federal Reserve (Fed) will maintain elevated interest rates for longer.

Investor focus is now turning to Tuesday’s release of US Consumer Price Index (CPI) data, which is seen as an important guide for the Fed’s policy path. Projections point to a 0.1% month-on-month decline in June’s headline CPI, while core CPI is expected to increase by 0.3% over the same period.

Market participants are currently pricing in one additional Fed rate hike before year-end, keeping US monetary policy firmly in the spotlight. As a result, attention is concentrated on Fed Chair Kevin Warsh’s first official testimony before the US Congress, scheduled for Tuesday, which is expected to be closely scrutinized for signals on the policy outlook.

BoE Expectations Help Cushion Sterling

Despite the current downside pressure on the pair, the British Pound’s losses against the USD may be limited by expectations surrounding the Bank of England (BoE). Traders are looking for at least one 25-basis-point rate increase from the BoE by the end of 2026, which provides a degree of medium-term support for GBP and helps cap further weakness in GBP/USD.

Political Developments in the UK

On the domestic political front, concerns about leadership stability in the United Kingdom have eased. Market sentiment has improved following reports that former Greater Manchester mayor Andy Burnham has won strong backing from Labour MPs to succeed Keir Starmer as Prime Minister. This has contributed to reducing political risk premia associated with the Pound.

Pound Sterling: Structure and Drivers

The article also provides background on the nature of the Pound Sterling and the key factors that influence its value in global markets.

What Is the Pound Sterling?

The Pound Sterling (GBP) is described as the oldest currency in the world (886 AD) and serves as the official currency of the United Kingdom. It is characterized as the fourth most traded currency in the foreign exchange (FX) market, accounting for 12% of all transactions and averaging $630 billion a day, according to 2022 data.

Key GBP currency pairs highlighted include:

• GBP/USD, commonly referred to as “Cable”, representing 11% of FX trading
• GBP/JPY, known among traders as the “Dragon”, with a 3% share
• EUR/GBP, accounting for 2% of transactions

The Pound Sterling is issued by the Bank of England (BoE).

Role of the Bank of England in GBP Valuation

The Bank of England’s monetary policy decisions are identified as the single most important factor influencing the Pound’s value. The BoE’s primary mandate is “price stability” – maintaining inflation at around 2%.

Its main policy instrument is the adjustment of interest rates:

• When inflation runs too high, the BoE raises interest rates to cool demand by making credit more expensive for households and businesses. This is typically supportive for GBP because higher yields can attract foreign capital.
• When inflation is too low, signaling weaker economic momentum, the BoE may cut interest rates to lower borrowing costs and encourage investment, which can weigh on the currency.

Economic Data and Trade Balance Effects on the Pound

Economic releases play a central role in shaping expectations for growth and monetary policy, thereby affecting the Pound’s performance. Indicators such as GDP, Manufacturing and Services PMIs, and labor market data can all move GBP:

• Robust data tends to support Sterling by attracting investment and potentially prompting tighter BoE policy.
• Soft data can pressure the currency lower as it raises concerns about growth and may lead to looser policy.

The trade balance is also cited as a significant driver. It measures the gap between export revenues and import expenditures over a given period. A positive trade balance, where exports exceed imports, can strengthen a currency by increasing foreign demand for domestic goods and, by extension, the domestic currency. Conversely, a negative trade balance can be a headwind for the currency.