Sterling Climbs to 1-Month High after Budget Plans

The British pound fell toward $1.33, its weakest level since December 9, as investors weighed the potential economic impact of the escalating Middle East conflict alongside rising inflation pressures and the possibility of a more hawkish Bank of England stance. Regional tensions escalated as Israel struck Beirut on Friday, after ordering the unprecedented evacuation of the city’s southern suburbs, marking a significant expansion of its war against Iran, launched a week ago in coordination with the US. Meanwhile, President Trump claimed a role in choosing Iran’s next supreme leader following Ayatollah Khamenei’s reported death. The resulting surge in energy prices is expected to keep inflation elevated across Europe, limiting the likelihood of a Bank of England rate cut. UK money markets now assign less than a 20% chance of a rate cut this month, down sharply from over 80% before the conflict, while UK rate futures price less than a 50–50 chance of a single cut by the end of 2026.

Sterling traded around $1.335, close to its weakest level since December 9, as investors weighed the potential impact of the escalating Middle East conflict alongside rising inflation pressures and the prospect of a more hawkish stance by the Bank of England. The conflict has intensified sharply, with a US submarine sinking an Iranian warship near Sri Lanka and NATO air defenses intercepting an Iranian ballistic missile fired toward Turkey. Investors also considered the implications of rising energy costs for UK monetary policy. Markets now assign just a 20% probability of a rate cut this month, and anticipate only a single 25bps reduction in borrowing costs for the year. Meanwhile, the Office for Budget Responsibility revised down the UK’s 2026 growth forecast to 1.1%, from 1.4% in November, even before accounting for potential energy shocks. Growth projections for 2027 and 2028 were raised to 1.6% for both years, alongside expectations for lower borrowing and subdued inflation.

Sterling climbed to $1.338, recovering some of the early-week losses that had pushed it near three-month lows, as the dollar eased following reports that Iran offered to discuss terms for ending the war. The New York Times reported that, a day after US-Israel attacks began, operatives from Iran’s Ministry of Intelligence made an indirect approach to the CIA. Israeli officials, however, have advised Washington to disregard the overture for now. Investors also weighed the impact of rising energy costs on Bank of England policy. Markets now see just a 20% chance of a cut this month, down from 75% last week, and price only a single 25-basis-point reduction for the year. Meanwhile, the Office for Budget Responsibility lowered its 2026 UK growth forecast to 1.1% from November’s 1.4%, even before factoring in energy shocks, but projected stronger growth of 1.6% in both 2027 and 2028, alongside lower borrowing and inflation expectations.