USD: A higher bar for dollar bulls
Rising oil prices have fuelled a performance gap between commodity-linked currencies and those reliant on imported energy since the conflict re-escalated around 10 July. At the same time, investors have stopped short of full panic mode, continuing to view the renewed escalation as part of a broader strategy to gain leverage at the negotiating table. That relatively complacent backdrop has amplified the divergence. Risk-sensitive commodity currencies such as the NOK, AUD and CAD have avoided the heavy sentiment-driven selling typically associated with geopolitical flare-ups. USD/NOK, for example, is down more than 3% so far this month.
Against this backdrop, the dollar’s safe-haven appeal has yet to fully re-emerge. DXY’s performance during this latest phase of the conflict has been noticeably more restrained, with the index still unable to break above late June’s high of 101.800.
This week’s main event is the July FOMC policy meeting. No change in rates is expected, although markets continue to price in close to two hikes by year-end. It is unclear how much additional support the dollar can draw from the meeting. There will be no updated economic projections, and June inflation data have come in softer than expected. While oil prices have moved higher, the overall balance of risks appears little changed, making it difficult to extract a meaningfully more hawkish message from the FOMC.
The backdrop still favours a cautious, data-dependent approach, something markets already anticipate. Adding to this, Kevin Warsh is unlikely to be perceived as either notably hawkish or dovish given his aversion to forward guidance.
As such, the bar for further dollar gains appears considerably higher, even from its two clearest bullish drivers: geopolitical risk and a hawkish Fed. Time, however, remains an important variable. The longer the conflict drags on, the greater the likelihood that the dollar’s safe-haven bid re-emerges.
EUR: Familiar stagflationary dilemma faces euro
The euro came under renewed pressure last week as EUR/USD broke below the 1.14 handle, reinforcing the downside bias that has been building for several weeks. Notably, the breakdown occurred despite increasingly hawkish ECB rhetoric, underlining a key theme: hawkish rate repricing is no longer translating into a stronger euro.
ECB President Lagarde acknowledged that some Governing Council members considered a rate hike last week, reinforcing expectations that the ECB could tighten again in September. Yet the market reaction was muted. Investors remain more concerned about the eurozone’s vulnerability to the renewed Middle East escalation, which is simultaneously pushing up energy costs and darkening the growth outlook.
This dynamic was evident in Friday’s PMI data. On the surface, the surveys were encouraging, with the composite index rising to 51.9 from 50.0, signalling a pickup in activity. Manufacturing and services both improved, while new orders and employment also strengthened. Under normal circumstances, such data would have supported the euro.
However, markets largely looked through the improvement. The surveys were compiled before the latest surge in oil prices and therefore do not fully capture the renewed geopolitical uncertainty. With crude prices up sharply since then, investors are increasingly focused on what higher energy costs mean for eurozone growth, inflation and competitiveness over the coming months.
The result is a familiar stagflationary dilemma. Rising energy prices may justify a more hawkish ECB, but they also weaken the economic backdrop that the currency ultimately reflects. As we’ve argued for several weeks, this leaves the euro in a difficult position: lower yields undermine the currency’s rate appeal, yet higher yields driven by energy shocks and worsening growth prospects are not especially euro-positive either.
Compounding the problem, markets remain focused on relative rather than absolute rates. While the ECB is edging towards further tightening, elevated energy prices are also reinforcing expectations that the Federal Reserve may need to stay restrictive for longer. As a result, two-year EUR/USD real rate differentials have widened back to their most dollar-supportive levels since late 2024, highlighting how the underlying yield backdrop has shifted against the single currency.
Unless tensions in the Middle East ease meaningfully, downside pressure looks likely to persist. With growth concerns rising, energy prices elevated and real rates increasingly favouring the dollar, markets are increasingly questioning whether EUR/USD can sustainably hold above the mid-1.13s.
GBP: MPC risks tilt against sterling
Last week, sterling underperformed the commodity-linked currencies, AUD, CAD and NOK, as surging energy prices boosted support for commodity exporters.
GBP/USD also moved lower after rallying from June’s 1.32 lows to almost 1.36 by mid-July. These levels have acted as key support and resistance zones since 2025.
Amid the recent Middle East re-escalation, markets have been far more reluctant to price in additional BoE tightening than when the conflict first erupted. Only around 60% of a September rate hike is currently priced, compared with a fully priced move for the ECB and almost one for the Fed. BoE Governor Andrew Bailey has shown little urgency to tighten policy in recent communications, while a softening labour market and broader economic weakness support a more cautious, data-dependent stance.
It was also notable that last Friday’s July Decision Maker Panel survey undershot expectations for a third consecutive month. Given the survey’s importance to the BoE, the latest release offers little evidence that further tightening is warranted in the near term. While a largely non-committal tone is expected from this week’s policy meeting, attention may shift to the vote split and updated projections. The June meeting resulted in a 7-2 vote, with two MPC members backing a rate hike. Meanwhile, inflation in Q2 2026 came in well below the BoE’s forecast of 3.1%, averaging just 2.8% over the quarter.
With oil prices rebounding, any downward revisions to the inflation outlook may be limited, but they could still send a sufficiently strong signal that rate hikes are off the table for now.
We see modest downside risks for sterling from this week’s MPC meeting.
Market snapshot
Table: Currency trends, trading ranges & technical indicators
Key global risk events
Calendar: July 27-31
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