Pound Drops Below $1.35 as Surging Oil Prices and Fed Hike Bets Boost Dollar

The British pound and the euro weakened against a broadly stronger U.S. dollar on Monday, driven by a surge in oil prices and mounting expectations for a hawkish interest rate hike from the Federal Reserve later this week.

Dollar Gains on Geopolitical Risk and Fed Outlook

In early trading, the GBP/USD currency pair fell 0.33% to 1.3482, breaking below the significant $1.35 threshold. The EUR/USD pair also declined, dropping 0.55% to 1.1535 and falling through its previous support level of 1.1600, according to data from Investing.com.

The dollar's strength was underpinned by a sharp rise in energy costs. Brent crude futures jumped more than 3% after Saudi Arabia was forced to shut down its East-West pipeline following a drone attack originating from Iraq, according to reports. This escalation in geopolitical tension in the Gulf region stoked safe-haven demand for the U.S. dollar.

Hawkish Fed Expectations Intensify

Markets are now almost fully pricing in a Federal Reserve interest rate increase on Wednesday, with analysts noting that last week's higher-than-expected U.S. CPI data has all but guaranteed a move. Francesco Pesole, a foreign exchange strategist at ING, stated that a hawkish signal from the Fed could help "rebuild a positive correlation between the dollar and Treasury yields," enhancing the dollar's safe-haven appeal.

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Pesole noted that a return for the Dollar Index (DXY) to the 99.50-100 range "remains a very realistic scenario." ING also highlighted that traders are watching for potential fiscal stimulus from the White House ahead of mid-term elections, which "could trigger a rise in the dollar's risk premium."

Sterling and Euro Pressured by External Factors

The pound's decline on Monday was not driven by domestic fundamentals. Strategists attributed the currency's weakness entirely to the widespread strength of the U.S. dollar, as there were no significant UK economic data releases or comments from the Bank of England to act as a catalyst.

For the euro, market participants are looking ahead to Germany's ZEW Economic Sentiment index and speeches from several European Central Bank officials, including President Christine Lagarde. While hawkish signals from the ECB last week may slow the euro's descent, ING said its near-term target for EUR/USD remains 1.1500, as the bank's macro team is "skeptical" about the prospect of further ECB rate hikes.