Image © Adobe Images
An incredible stock bull run and the war in the Middle East have been supportive of the pound.
The pound to euro exchange rate (GBP/EUR) rose on Monday as foreign exchange markets tacked onto a rise in UK bond yields, a move linked to the latest developments in Iran.
In fact, the data is clear: the war in the Middle East has proven a supportive development for the pound, suggesting any further episodes of escalation could prove supportive and lift GBP/EUR back to 1.16.
Likewise, the major risk to the pound is a lasting and enduring peace where oil prices fall.
The chart shows that the pound-euro exchange rate rose at the start of the conflict in tandem with the two-year gilt yield, with subsequent peaks at 1.16 reflecting a similar spikes in the yield.
The yield is important as it closely tracks what investors think the Bank of England will do to interest rates. In short, this is a market that sees rises in Bank Rate in the coming months.
And that is in turn a judgement on inflation; the war has raised oil and gas prices, which will feed into higher levels of domestic inflation in the coming months.
The pound rose against the euro on Monday after weekend news of renewed escalation in the Middle East, which was topped off by Iran's announcement it was ceasing communications with the U.S. due to Israel's latest offensive in Lebanon.
Oil prices rose in response, gilt yields followed suit and GBP/EUR recorded a 0.27% daily gain to close at 1.1563.
This is counterintuitive behaviour: typically, we would expect the pound to fall against the euro and dollar when risk sentiment deteriorates, which was the case yesterday.
The bull run supports pound sterling
But, it's worth noting the broader background conditions: stocks are well supported and we're in fact witnessing an incredible bull market as the AI trade tears ahead.
This cyclical bull is 45 months old, surging over 80% and logging more than 200 new all-time highs.
We're clearly in a 'risk on' phase, despite what's going on in the Middle East. The combination of supportive risk and higher yields is therefore proving a supportive combination for the GBP/EUR.
Risks to the view are a setback to the market's strong run and a sharp fall in inflation expectations that would weigh on UK gilt yields, most likely linked to a decisive end to the Iran conflict and the reopening of the Strait of Hormuz.
"Investors have been remarkably willing to look through the setbacks," says Nigel Green, CEO of deVere Group. "Every time tensions increased, the prevailing view was that diplomacy would eventually catch up. At some stage markets stop giving negotiations the benefit of the doubt."
Do you think the exchange rate will fall from here?
Then today's rate is worth protecting.
Fix it now for a transfer up to 12 months ahead.
Set a target. Let the market come to you.
We execute automatically when your rate arrives.
