In early Asian trading on Thursday, the GBP/USD pair traded within a narrow range around 1.3530. Earlier, cooler-than-expected US inflation data had pushed the pair to reach a new high since May 13 at 1.3557. However, safe-haven demand for the US dollar, fueled by escalating tensions between the US and Iran, capped further gains for the pound.
The ongoing escalation of US-Iran conflict, marked by a new round of US airstrikes, has heightened risks of energy-driven inflation, bolstering safe-haven demand for the dollar and simultaneously pressuring the pound. Market focus has now shifted to the upcoming UK monthly GDP and US retail sales data due later in the session.
Inflation Signals Continue to Cool Following CPI, PPI Data
Data from the US Bureau of Labor Statistics showed the US Producer Price Index rose 5.5% year-on-year in June, down from a revised 6.0% in May and below market expectations of 6.2%. On a monthly basis, the PPI fell 0.3% in June, a significant slowdown from a revised 0.6% increase in May and better than market forecasts of no change. This clear deceleration in US producer inflation has reinforced market expectations that the Federal Reserve will keep interest rates steady.
Following the data release, market expectations for a Fed rate hike at the July policy meeting diminished further. Market pricing indicates traders now see only about a 10.2% probability of a July hike, down from 16.6% prior to the data. This follows cooler-than-expected US Consumer Price Index data for June, which further solidified market expectations for a more cautious monetary policy pivot.
Geopolitics: US Strikes Iran Again, Safe-Haven Demand Boosts Dollar
The escalating US-Iran conflict is a key driver behind the pound's weakness.
The US military launched a new round of strikes on targets in Iran on Wednesday night, including locations on Qeshm Island, Bandar Abbas, and in Sistan and Baluchestan province, aiming to keep the Strait of Hormuz open.
Iran's chief negotiator issued a strong statement, saying Iran had "no reason to continue adhering" to the memorandum of understanding if it did not benefit.
Tensions in the Strait of Hormuz have pushed oil prices higher, exacerbating concerns about energy-driven inflation.
For the pound, the transmission of geopolitical risk is twofold: first, safe-haven sentiment directly boosts the dollar; second, rising oil prices reinforce expectations for Bank of England rate hikes. While rate hikes typically support a currency, the current market is more inclined to trade on safe-haven dollar demand.
Monetary Policy: Markets Increase Bets on Bank of England Rate Hikes
Surging oil prices are altering market expectations for the Bank of England's policy path.
Money markets have fully priced in one rate hike for the November policy meeting and have also priced in a second hike by April 2027. Prior to the outbreak of US-Iran hostilities, markets had anticipated two rate *cuts* from the BoE this year. This sharp reversal in policy expectations reflects market fears that energy inflation could seep into broader price pressures.
The BoE Governor has previously noted that a 13% increase in the energy price cap in July is working through household bills, with the central bank itself expecting inflation, currently at 2.8%, to rebound above 3.5% by year-end.
While rising rate hike expectations would normally be supportive for sterling, in the current market environment dominated by geopolitical risk, safe-haven demand for the dollar is outweighing interest rate differential factors.
Domestic Politics: New Prime Minister Imminent, Chancellor Appointment in Focus
With Andy Burnham expected to formally take office as UK Prime Minister on July 20th, market attention has swiftly shifted from the political transition to his key cabinet appointment—the Chancellor of the Exchequer.
The UK's public finances are currently fragile, with both deficit pressure and debt levels elevated. The fiscal policy direction of the new government will become the next major variable for the pound.
While investors had largely priced in political uncertainty, significant uncertainty remains regarding the new Prime Minister's specific spending plans, tax adjustments, and fiscal consolidation path.
If these policy details lean towards expansionary spending or fail to effectively control the deficit, they could push UK government bond yields higher and exert downward pressure on sterling. Conversely, a demonstration of prudent fiscal discipline could boost market confidence.
Outlook: Geopolitical Risk Drives Short-Term Moves, Focus on GDP and Retail Data
Overall, the short-term direction of GBP/USD will continue to be driven by geopolitical developments in the Middle East. If US-Iran tensions escalate further, safe-haven dollar buying could push the dollar higher, potentially testing the 1.3500 level or lower for the pound. If signs of de-escalation emerge, sterling could see a technical rebound, targeting the 1.3580-1.3600 area.
The UK monthly GDP and US retail sales data due later today could provide additional catalysts for short-term moves. Markets expect UK GDP to have grown 0.1% month-on-month, recovering from a previous -0.1%. Weaker data could further weigh on sterling. US retail sales are forecast to slow to 0.2% month-on-month from 0.9%; stronger-than-expected data could boost the dollar.
As of 12:10 Beijing time, GBP/USD was trading at 1.3531/32.
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