Risk aversion has been sweeping through financial markets so far this week due to the heightened tensions in the Middle East.
Equity markets worldwide are trading lower and perceived ‘safe haven’ currencies (e.g. USD) have outperformed most of their peers. The involvement of Iran in the conflict is a worrying development for markets, with investors rightly fearful that retaliation from Israel could disrupt global oil supplies - Iran is the seventh largest oil producer in the world. Israel’s PM Netanyahu has vowed to strike back, and we would expect another leg upwards in oil should these threats materialise, particularly should it target the country’s oil refineries.
The USD had already strengthened earlier this week following some hawkish comments from Fed chair Powell and yesterday’s US services data (ISM) has dramatically reduced concerns over an imminent slowdown in the US, which has further bolstered the dollar. Investors’ focus will now turn to this afternoon’s non-farm payroll figures (1.30pm) for further clues on the state of the US labour market and how this will interest rate expectations.
Sterling lost ground yesterday following some surprisingly dovish comments from Bank of England chief Andrew Bailey. Markets were caught off guard as, seemingly out of nowhere, Bailey said that the bank could be ‘a bit more activist’ on rate cuts should we see further good news on UK inflation. Although the UK data has not necessarily deteriorated to an extent that would warrant such a shift in policy stance from the BoE since their last meeting and inflation remains in line with their forecasts, the comments were enough for markets to increase their expectations of more aggressive rate cuts from the BoE, which weakened the Pound. However, cautious comments from BoE Chief Economist Huw Pill this morning have provided a little bit of support Sterling. He said that "Further cuts in the bank rate remain in prospect but it will be important to guard against the risk of cutting rates either too far or too fast".
As a result, the GBP/USD rate is trading around 2.5 cents lower than where it started the week and touched a 3-week low earlier. The GBP/EUR dropped over 1% yesterday to hit a 2-week low but has since recovered 0.5 cent. The EUR/USD has dropped around 1.5% this week and trades around a 3-week low.
