Pound Edges Higher as Middle East Tensions Lift Oil, Support Hawkish Fed Outlook

The British pound traded slightly higher against the dollar on Thursday, but the greenback maintained broad support as escalating geopolitical tensions in the Middle East pushed oil prices higher, strengthening the case for the Federal Reserve to maintain its hawkish monetary policy.

As of 07:57 AM ET (11:57 GMT), the GBP/USD pair rose modestly to 1.3390, while the EUR/USD climbed to 1.1429.

Oil Surge Underpins Dollar Strength

The dollar found support after U.S. forces conducted strikes on infrastructure targets in northern Iraq, an escalation that briefly pushed Brent crude oil prices above $80 a barrel. Higher energy costs can contribute to inflation, giving the Federal Reserve more reason to keep interest rates elevated for longer.

"Higher energy prices will provide fuel for the Fed hawks and keep the dollar supported on dips," said Chris Turner, Global Head of Markets at ING, in a note. Turner suggested the Dollar Index (DXY), which was trading near 101, could climb back toward the 101.50 area. This sentiment follows recent FOMC minutes where officials viewed a delayed rate cut and an immediate hike as "equally credible" scenarios.

Sterling Gains on Market Dynamics

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Analysts noted that sterling's gains were not driven by UK economic fundamentals. According to ING, the currency's performance mirrors a pattern seen in previous geopolitical flare-ups where the front end of the sterling money-market curve adjusts more sharply than its eurozone counterpart.

This dynamic tends to put downward pressure on the EUR/GBP cross. ING also highlighted that the long-term downtrend in the GBP/CHF pair could be turning, with 1.10 seen as the next target if energy prices stay high, given expectations that the Swiss National Bank will be the last G10 central bank to raise rates.

Euro Holds Firm Amid Shifting Rate Bets

The euro has remained "remarkably well" supported despite the spike in oil, according to ING. The resilience comes as money markets increase bets on another European Central Bank rate hike in September, with pricing implying a 22 basis point increase. This has caused euro swap rates to rise more sharply than short-dated U.S. rates.

Despite this, ING stated that "the Fed story will be a more dominant theme," suggesting the euro could give back its gains and trade back below the 1.14 level. Market participants are now looking ahead to remarks from New York Fed President John Williams later on Thursday and key U.S. CPI data next week for further direction.