Sterling Firms as Mideast Tensions and Oil Spike Bolster US Dollar

The British pound traded slightly higher against the dollar on Thursday, though broader market focus remained on geopolitical tensions that pushed oil prices higher and strengthened the case for a hawkish Federal Reserve.

As of 07:57 AM ET, the GBP/USD pair rose modestly to 1.3390. Meanwhile, the Dollar Index (DXY), which measures the greenback against a basket of currencies, traded near 101 as investors weighed the latest developments.

Geopolitical Risk Lifts Oil and Dollar

The dollar found support after U.S. forces conducted airstrikes on infrastructure targets in northern Iraq overnight. The escalation, described as the first of its kind since early April, caused Brent crude oil prices to briefly surge above $80 a barrel.

According to analysis from ING, rising energy costs are likely to reinforce the Federal Reserve's cautious stance on inflation. "Higher energy prices will provide fuel for the Fed hawks and keep the dollar supported on dips – particularly against the low yielders," said Chris Turner, Global Head of Markets at ING. The bank suggested the DXY could climb toward the 101.50 level.

This sentiment follows Wednesday's Federal Open Market Committee (FOMC) minutes, which showed officials viewed the scenarios of a delayed rate cut or an immediate hike as "equally credible."

Sterling Gains on Technicals, Not Fundamentals

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Analysts noted that sterling's minor gains were not driven by underlying strength in the UK economy. Instead, ING pointed to a pattern where geopolitical flare-ups cause the front end of the sterling money-market curve to adjust more sharply than the eurozone's, putting downward pressure on the EUR/GBP cross.

ING also highlighted that the long-term bear trend in the GBP/CHF pair may be turning, with 1.10 as a potential next target if elevated energy prices persist. This is partly due to expectations that the Swiss National Bank will be the last G10 central bank to raise interest rates.

Euro Holds Ground as ECB Bets Rise

The euro proved resilient in the face of the oil price spike, with EUR/USD climbing to 1.1429. According to ING, the currency's stability is linked to rising euro swap rates, which reflect growing market bets on another European Central Bank rate hike in September. Money markets are currently pricing in an additional 22 basis points of tightening.

Despite this, ING believes the Federal Reserve's policy path will be the more dominant theme for currency markets. The bank stated it expects EUR/USD could give back its gains and trade back below the 1.14 level. Investors are now looking ahead to comments from New York Fed President John Williams and the release of June U.S. CPI data next week for further direction.