USD: Clouded by the fog of war
The Fed held rates at 3.5%–3.75% in an 11–1 vote, but “hawkish pause” is not an accurate label. What came out from the press conference was a central bank unsure that policy is meaningfully restrictive, even as its cautious dot plot and modestly higher forecasts signal little appetite to ease. Powell hinted that monetary policy under supply shocks works less under current circumstances, with policy sitting near the line between restrictive and not. Markets heard the ambiguity and pushed the easing path further out, not because growth looks strong, but because the Fed has less room to respond cleanly, given the high level of uncertainty.
Inflation is also getting messier. Price pressure is tilting back toward goods just as the labor market continues its 2025 weak performance, a mix that stretches policy on both sides. Tariff effects are filtering in slowly enough to confuse, yet clearly enough to lift forecasts, while higher oil tightens the whole macro backdrop. This is a story of persistent inflation meeting decelerating hiring and a squeeze on real incomes that could come from sustained higher gas prices. The wait-and-see pattern in North American central banks will dictate policy outlook in the near future. The reality is, we’re six weeks away from next Fed meeting, and there’s nothing but uncertainty on how things could unfold in the very next few days. For how long policy gets stuck, will depend on, as mentioned previously, duration and degree of the US-Iran conflict.
The February PPI didn’t help. Final demand rose 0.7% m/m and 3.4% y/y, with core at 3.9% y/y, hot prints that landed into a worsening Middle East backdrop. Brent surged above $109 as Israel struck Iran’s upstream South Pars gas field and Iran flagged Gulf energy targets, prompting precautionary evacuations at Samref and Jubail. Missiles and drones have targeted oil infrastructure, contingency routes are straining around Hormuz, the US Navy’s carrier exit from the Red Sea opened a security gap, and shipping mandates were waived to ease domestic costs. Layer these shocks on top of sticky PPI and the path to lower inflation looks clouded by the fog of war.
For the US dollar, that mix is supportive. Even as officials maintained a highly cautious outlook, projecting just one quarter-point rate cut for 2026 and another for 2027, the greenback firmed after the press conference as futures still hesitate to price a cut before Q4. Most importantly, the US dollar index remains highly tethered to headlines out of Iran. Near term, dips likely stay shallow until shipping, storage, and insurance conditions around Hormuz improve and the conflict premium fades, something current news flow does not yet allow. A further leg up in the USD hinges on energy and volatility flaring again, but with policy “stuck,” inflation not fading broadly, and risk premia elevated, the balance of risks keeps the dollar bid on setbacks.
GBP: BoE to remain in “wait and see” pattern
The Bank of England meets today in a completely different world to the one it faced just a month ago. Before the Middle East war erupted, the path was straightforward: the labour market was cooling, inflation was on track to hit target by April, and the MPC had narrowly held rates in a 5–4 split that all but teed up a cut in March or April. Markets were effectively debating the timing, not the direction.
That narrative has been overturned. The UK is among the most energy‑sensitive economies in the G7, and the surge in oil and gas prices has forced a wholesale reassessment of the inflation outlook. The war has rendered previous forecasts obsolete, and the expected disinflation path has been replaced by a renewed risk that CPI remains above target into 2026. As a result, markets have priced out all cuts for this year and now assign a non‑trivial probability that the next move is a hike if the energy shock proves persistent.
The MPC will hold today — the shock is too recent and the uncertainty too high — but the communication will be closely scrutinised. Policymakers must balance two conflicting realities: a softening domestic economy, with rising youth unemployment and increasingly cautious private‑sector hiring, and an external inflation shock that the Bank cannot ignore. The question is whether the MPC chooses to “look through” the energy spike, as it arguably did in 2011, or treat it as a more durable inflation risk, as in 2022. The truth likely lies between the two: the UK is no longer in a deflation‑prone world, but neither is it facing the broad‑based overheating seen two years ago.
For sterling, this backdrop creates a two‑way risk. The aggressive repricing in UK yields has supported GBP against European FX, but the broader terms‑of‑trade shock still argues for caution. A hawkish tone today could give the pound a tactical lift, yet sustained upside requires the energy shock to fade. A protracted conflict keeps the balance of risks skewed toward renewed GBP underperformance, consistent with options markets, where downside protection remains markedly more expensive than upside.
Bottom line: Although no change is to policy is expected today, the guidance provided will be key in judging the reaction function amid the geopolitical turmoil.
EUR: ECB won’t move the euro
The euro came under renewed pressure yesterday as Iran escalated threats to key energy assets in the Gulf following Israel’s strike on the South Pars gas field. Oil prices climbed on the headlines. Markets appear to be parsing Iran’s stance more acutely than Washington’s: Trump’s earlier comment that the “war may be ending in the near future” barely registered, while Iran’s warnings stuck. After all, Iran holds the greater leverage over energy markets through its de facto control of the Strait of Hormuz. Reignited pressure on government yields across the eurozone underscores how sensitive curves remain to geopolitics, reversing some of the early‑week normalisation ahead of a heavy central‑bank calendar, while blurring the pass-through into FX.
We expect a muted reaction from the euro to today’s ECB meeting. While the Bank will likely acknowledge the upside risks the conflict poses to inflation, we expect it to remain non‑committal. And although we will get updated staff projections, it is unlikely that any conflict‑related inflation impulse will be incorporated – at least not in the March round. One may argue that risks for the euro tilt to the downside: the market is currently pricing almost two full 25‑basis‑point hikes, and any acknowledgment by Lagarde of risks to the growth outlook would temper a more hawkish market bias, triggering an unwind. That said, FX sensitivity to rate differentials has deteriorated sharply since the conflict began, and also the knee‑jerk hawkish repricing lacks substance at this early stage, with little clarity on the macro implications – meaning the euro is unlikely to move much even if some of that hawkishness is unwound after the meeting.
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